The Impact of Debit Card Regulation on Checking Account Fees

In 2010, when Congress authorized the Federal Reserve to cap the fees paid to banks for debit card transactions, some news reports predicted the banks might react by increasing checking account fees. The cap on debit card fees reduced revenue significantly for some banks, and the concern was that they might seek to offset their losses by raising more revenue from checking accounts. In fact, in recent years, many of the large banks bound by the new debit card regulations have raised their checking account fees. But thousands of smaller banks that were exempted from the regulations have taken varying approaches to checking account fees. Some have raised the fees. Others have lowered them. The net effect on consumers has remained an open question. After the imposition of debit card regulations, have changes in checking account fees benefited or hurt bank customers? What factors drove some banks to change their fees and others not? Were competitive forces important in the banks' decisions?

This article examines broad samples of regulated and exempt banks, compares their fee structures before and after the imposition of debit card regulations, and finds that--on net--consumers actually had increased access to free checking after the debit card regulations went into effect in late 2011. Regulated banks were more likely to raise checking account fees, but exempt banks were more likely to reduce or eliminate fees. Thus, consumers' net increase in access to free checking stemmed mainly from the greater availability of free checking at exempt banks. At some banks, both regulated and exempt, there were also other changes in the terms of the checking accounts offered to consumers. This article finds evidence that access to free checking has expanded most in cities and regions where banks are engaged in vigorous competition: banks in such markets may offer free checking to attract customers from other banks or to ensure retention of their own established customers. Section I describes the potential for debit card regulations to drive changes in checking account fees and outlines an approach to assessing what changes actually occurred--comparing data from before and after the regulations were imposed. Section II examines the changes in checking account fees that have occurred and explores banks' decisions on whether to offer unconditional free accounts or conditional free accounts for which customers must meet certain terms and conditions to avoid fees. Section III examines the market characteristics, financial factors, and competitive conditions that may have driven changes in checking account fees.

I. DEBIT CARD PAYMENTS, BANK ACCOUNT SERVICES, AND INTERCHANGE FEES

The changes in checking account fees that took place from 2011 to 2012 came after a decade of striking developments in the debit card market. Debit card use from 2000 to 2009 had soared from 12 percent to 39 percent of all noncash retail transactions, even as the number of those transactions swelled from 72 billion to 104 billion per year (Sullivan 2012). Over the same period, debit card networks sharply raised the fees charged to merchants for processing transactions. The largest share of these fees, known as "interchange fees," is passed on by the networks to the banks that issue debit cards. Interchange fees increased 33 percent from 2000 to 2011, rising from an average of 36 cents to an average of 48 cents for a $40 transaction. (1)

Merchants raised concerns about the rise in interchange fees and subsequently, Congress passed the Dodd-Frank Act of 2010, which included a cap on interchange fees. (2) The cap took effect in October 2011. (3) Congress exempted smaller banks--banks with parent companies having less than $10 billion in total assets--from the cap, but larger banks were bound by the cap and experienced immediate losses of revenue. For the regulated banks, the average interchange fee (counting fees for transactions of all sizes) quickly dropped from 50 cents to 24 cents per transaction (Hayashi 2012). Annual revenue from interchange fees dropped for all regulated banks by an estimated $8 billion (Wang). (4) The reaction of banks to regulated interchange fees Amid uncertainty about how regulated banks would react to these revenue losses, some banking industry observers predicted a rise in checking account fees and widespread elimination of free checking accounts for consumers. Other observers predicted survival of free checking at small banks. (5)

Both predictions are defensible because a variety of factors influence how commercial banks manage the pricing and costs of checking account services. (6) Although the loss of revenue from interchange fees is one key factor, other factors also influence prices, including: the characteristics of the regional market in which a given bank operates; the financial characteristics of the individual bank itself; and the nature of the industry competition faced by the bank. For example, in regional markets that are growing in size and affluence, banks may place a higher value on gaining market share than on increasing account fees. Individual banks' financial characteristics, such as their access to funding or the level of demand for their loans, may affect those banks' decisions on whether to raise account fees. (7) And the nature of the competition faced by banks within their regional market may influence whether they are inclined to raise fees at the risk of losing price-sensitive customers to rivals.

Numerous factors influence banks' management of checking account products and their reactions to interchange fee caps have not been uniform. Loss of interchange fee revenue is likely to lead some regulated banks, but not all, to raise account fees. While interchange fee regulation does not apply to exempt banks directly, it may have had an indirect effect on the pricing of some checking account products. After a regulated bank raises its checking account fees, rival banks--including exempt banks--may follow with their own fee increases because they perceive less risk of losing customers. Conversely, an exempt bank may react by lowering its own account fees in a competitive move to attract customers.

The before-and-after method used to analyze checking account requirements and fees

In studying how commercial banks reacted to the regulation of debit card interchange fees, this article examines separate samples of regulated and exempt banks. The analysis compares consumer checking account, financial, market, and competitive characteristics of sample banks before and after interchange fee caps went into effect. The first set of data on fees and requirements of banks' consumer checking accounts was collected in March and April 2011, at least five months before fees were regulated. A second set of data was collected in April to June 2012, six months or more after fees were regulated.

A criticism of this before-and-after method is that other factors may account for the changes it uncovers. A potential complication in the case of deposit services was a change in regulations, effective July 21, 2011, that allowed banks to pay interest on business checking accounts. (8) This change may account for a surge of checking account balances, which in 2011 increased 35 percent at commercial banks. (9)

The banks' new ability to pay interest on business checking accounts most likely caused the large increase in overall checking account balances rather than interchange fee regulation. In a recent survey on corporate payments, less than 5 percent of 484 respondents used or accepted debit cards in transactions with suppliers or other businesses (Association for Financial Professionals). Moreover, because business checking accounts are tied to a broad range of services--payroll, wire payments, and bill payment processing--free checking or minimum balances may have little relevance.

The emergence of interest payments for business checking accounts complicates the analysis of trends in checking account services in two ways. First, the surge in business checking account balances makes it difficult to detect whether consumers shifted their checking account balances from banks with free checking to banks without free checking because the information about checking account balances mixes consumer and business checking accounts. Second, most business checking account balances are held in larger, regulated banks. (10) As a result, the ratio of business deposits to total checking account deposits likely increased, and the increase was likely greater at regulated banks than at exempt banks. The analysis below offers a method for isolating the trends in consumer accounts from the trends in business accounts.

For several reasons, despite the challenges posed by the nature of the available data, the before-and-after assessment used in this article can help identify what changes in checking account fees were caused by interchange fee regulation. First, the imposition of interchange fee regulation itself defines the distinction between regulated and exempt banks considered in the analysis. Second, although many factors may have some effect on how banks price their deposit services, the interchange fee cap was a major contributor to the differences observed between regulated and exempt banks in their adjustments to the terms and fees of checking accounts. Finally, the regulation of interchange fees for debit card payments is the only distinct, major event in 2011 that directly and substantially affected banks' revenue from consumer checking account services.

II. AVAILABILITY AND COST OF COMMERCIAL BANK CHECKING ACCOUNTS

Analysis of checking account requirements and fees at regulated and exempt commercial banks shows some banks raised fees while others reduced them. Change was relatively uniform among regulated banks, which mostly raised fees on checking accounts. Many exempt banks changed their account offerings, however, and while some increased consumer fees, others reduced them. On balance, more exempt banks reduced fees, more than offseting the impact of regulated banks' raising of fees. On net, the changes resulted in increased availability of free checking accounts.

This section first discusses sample data on requirements and fees for checking accounts. It then examines the requirements and fees of two types of free checking accounts, unconditional and conditional."

Sample data and general characteristics of banks

Sample banks are drawn from all 6,389 commercial banks with nonzero checking account deposits at year-end 2010 (Table l). (12) The total population of banks had checking account deposits of $946 billion. In 2010, 163 of these banks were subject to interchange fee regulation and 6,226 were exempt. The shares of checking account deposits at regulated and exempt banks were 69 percent and 31 percent, respectively.

The regulated sample includes 41 banks from a list of 100 top issuers of debit cards in 2010 (Nilson 2010a; Nilson 2010b). (13) Banks in the regulated sample include many of the largest banks in the United States. The exempt sample contains 240 banks randomly selected from all exempt commercial banks. For each sample bank, fee information and requirements for various noninterest checking account products was obtained directly from the bank's website.

The 41 banks in the regulated sample held $548 billion, or 58 percent, of all checking account deposits at year-end 2010 (Table 1). By contrast, the 240 banks in the exempt sample combined held $15.4 billion, or 1.6 percent of all checking account deposits.

The sample banks have some differences compared with the groups from which they are drawn (Table 1). Average assets of the sample of regulated banks were $191 billion at year-end 2010, much higher than the average of $59. …

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