Financial Reform Could Hurt Consumers

NEW YORK ( TheStreet) -- A part of the financial-regulation bill, passed by the Senate yesterday, is a change in the interchange fee for debit cards. The change could benefit retailers but hurt banks and possibly harm consumers.

Under the legislation, the interchange fee that retailers must pay issuers and banks for debit-card transactions would be decreased. Currently, that fee is about 2% of every transaction. According to a recent study by the Nilson Report, interchange fees paid by merchants for MasterCard ( MA) and Visa ( V) debit transactions totaled nearly $20 billion in 2009. The legislation would not affect the interchange fee levied on credit cards.

How will interchange regulations affect consumers, retailers and banks?

1. Less convenient payments for small purchases. Credit cards make payments fast and easy, and we use them for the majority of our purchases regardless of the amount. Interchange regulations will allow retailers to set the minimum purchase price at $10 for credit card purchases. Shoppers must use cash for small purchases.

While minimum payments may be inconvenient for consumers, permission to set minimum payments is good news for small retailers. Currently, retailers are required to accept cards for all purchases no matter how small the price. The minimum fees are so high that retailers often lose money on the small purchases with small profit margins.

2. Consumers may save money with cash discounts. Merchants will be able to offer discounts to people who pay with cash, checks or debit cards. However, the regulations do not require merchants to pass savings to consumers.

3. Lower prices could lead to lower debt. Interchange fees add approximately 2% to the price of goods. Ideally, merchants will lower prices if they don't have to pay the fee. But, again, retailers are not required to pass the savings on to consumers.

4. New or higher fees for bank accounts. Banks will lose billions of dollars from this change in interchange fees and they will look for new ways to replace that revenue. It is possible the decrease in interchange fee revenue could mean higher fee payments for consumers with bank accounts. Wells Fargo ended free checking account on July 1, and Bank of America ( BAC) is testing new fees to be added by the end of the year. Other banks may follow.

5. A reduction or elimination of rewards for debit cards. Since some issuers have claimed that interchange fees fund the rewards programs, expect rewards from debit cards to shrink. Banks will likely not fund rewards out of their own pocket.

6. A possible reduction in rewards for tax and college tuition payments. Governments and colleges can set maximums for credit card payments to reduce their own interchange fees. This will limit the points or cash rebates available for those who pay taxes or tuition with a credit card.

While the government wants to regulate these billions of dollars, there is uncertainty about how much lower the fee will be. The bill requires that it be "reasonable and proportional" to the cost of processing the transaction. The Fed has the fee-setting authority and has not announced what it will be. The Fed will not directly regulate the network transaction fees that Visa and MasterCard charge banks. (Debit card transactions currently have uncapped fees, which sometimes reach 2% or more of the amount purchased.)

If the bill is signed by the president, it will be sent to the Federal Reserve to draft regulations within nine months. The new rates would go into effect 12 months after the bill is signed.

-- Reported by Bill Hardekopf of LowCards.com.
Bill Hardekopf is the chief executive officer of LowCards.com, which compares and rates more than 1,000 credit cards. He is the co-author of "The Credit Card Guidebook."