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

PRICING: A CONTINUING BARRIER TO DEBIT CARD GROWTH

As these technical barriers to debit acceptance continue to fall, future growth is likely to depend on whether consumers and retailers have an economic incentive to use debit in place of traditional payment methods. Unfortunately, the current system of pricing payment services may mute this incentive. Because consumers do not directly bear the costs of alternative payment methods, they are unlikely to choose debit over alternative payment methods based on cost. [6] For merchants, in contrast, debit pricing may be a crucial factor in to promote debit card use.

Pricing of existing payment services

Banks are the major providers of payment services for retail transactions. To cover the operating costs of cash, checks, and credit cards, banks charge fees both to consumers and to merchants. Banks price these services in two ways. In some cases, they levy a fee for each transaction. A bank might charge a depositor for each check written, for example, or it might charge a merchant for each cash deposit or bundle of checks. In other cases, banks impose account fees rather than transaction fees Some banks charge customers a flat monthly fee for maintaining a deposit account but permit the depositor to write an unlimited number of free checks. Similarly, banks generally charge consumers an annual fee for a credit card rather than a fee for each transaction.

The distinction between transaction-based fees and account-based fees has important implications for a consumer's or merchant's willingness to use a particular payment means. For example, if a consumer faces an explicit charge for a transaction, he is more likely to weigh this cost in deciding to use a particular payment method. In contrast, if payment pricing is account-based, the consumer is likely to see the marginal cost of a transaction as zero and his choice of payment method is more likely to be based on factors other than cost. [7]

Currently, consumers have little incentive to choose a payment method based on price. At the time of a retail transaction, for example, a consumer typically pays the same price for a purchase regardless of whether cash, a check, or a credit card is used. [8] There is a cost to each means of payment, of course, but this cost is only loosely related to the level of usage.

Payment methods are not differentiated by price for two reasons. First, largely for historical reasons, almost all bank charges to consumers are account-based rather than transaction-based. [9] For example, most consumers do not face a per-check fee for the use of checks. Instead it is common for banks to charge a flat monthly account maintenance fee which is often waived if the customer maintains a minimum balance. [10] Similarly, consumers who pay their credit card balance each month pay only an annual account fee, if they pay any fee at all. And, in the case of cash, while there can be a cost to obtaining cash through an ATM machine or a check-cashing outlet, this cost is not incurred at the time of a retail purchase. [11]