As I pointed out in my post last week on why banks were charging fees for debit cards, I predicted that the fees would not remain with us:
However, regardless of where you want to point the finger, I don’t think debit card fees will stay with us. First of all, as Beating Broke pointed out, consumers don’t need to put up with debit card bank fees:
Eventually, as the regulation piles up,and it becomes harder and harder for the banks to make any money on credit and debit cards, they’ll find more and more ways to fee us for those services and others. As the fees increase, more and more of us will revert to using cash as a medium of exchange. And the more of us who are using cash, the less of us are using those services which means they’ll have a smaller income on those services and will need to squeeze more fees out of the users.
A rise in the price at the register from retailers is far less conspicuous than a debit card fee. It’s never wise to try and pass on fees to customers who have easy access to free substitutions. I have doubts that banks will be able to pass these fees onto consumers without repercussions.
Since I pointed this out two weeks ago, Bank of America and other banks toying with the notion of charging debit card fees have retreated from the practice:
Last week, a person familiar with J.P. Morgan Chase told The Wall Street Journal that its Chase retail unit had decided to drop its test of debit-card fees. The bank had been testing $3 monthly fees for eight months in parts of Georgia and Wisconsin. Wells Fargo followed suit on Friday, announcing it was canceling its test of $3 monthly debit-card fees that had started in October.
SunTrust is dropping its $5 monthly debt-card charge on Wednesday and will refund the fee to customers who have incurred it. The Atlanta lender didn’t disclose how much money it has collected from the fee…
…Regions said it is eliminating the fee as of Nov. 1 and will also refund those fees that already have been charged. “We have heard from our customers and are responding to their feedback by eliminating the monthly fee,” said John Owen, head of consumer services for the bank.
It would be easy chalking this entire fiasco up as a victory for consumers, but when you understand the reason why banks dropped the fee, you realize that this development was more like a minor skirmish.
The Economics Behind Dropping the Debit Card Fee
Price elasticity is the economics behind optimizing prices so as to maximize your return. The idea is that quantities of a product demanded by consumers are not always price sensitive. There are some products where you can raise prices dramatically with little change in purchasing habits from consumers and other products where consumers will not pay even an extra penny for the product.
For example, I need transportation to work and the most viable option is to drive. Thus, regardless of how expensive gas gets, I rarely cut back on the number of gallons I use. Economists would call this price inelastic.
Meanwhile, I’m only going to buy the cheapest block of soap on the shelf. Thus, if my regular brand of soap raises its costs above its competitors, it would result in me switching to a new brand of soap. Soap, for me, is price elastic.
Whether or not a product’s demand is price elastic or inelastic is determined by a number of characteristics relating to consumers and products. How useful is a debit card to a consumer? How easy would it be for consumers to use something else or switch to another bank?
What happened to banks was far worse. In the case of debit card fees, price was more elastic than the banks realized. They miscalculated consumer’s reactions thinking that they’d see a loss of business in their debit card usage and didn’t realize that raising the price of debit cards would result in a substitution of all banking products. If debit cards were soap, should Unilever raise the price of their dove soap it would mean a large population of consumers would not only switch to a new brand of soap, but also body spray, tea, mayonnaise, margarine, noodles and diet drinks.
Obviously, banks were ready to take a hit in debit card usage, which is probably why the fee was as steep as $5. What they didn’t realize is that their other financial products were going to be affected.
The Economics of Tax Shifting
While the debit card fee may have died, as I said in my introduction, the story is far from over. That is because price elasticity is only a part of a much larger macroeconomic shift going on in the financial industry.
My article last week showed that the debit card fee wasn’t a random money making scheme, it was in response to lost debit card transaction revenues imposed by last year’s Frank-Dodd financial regulatory reform legislation. While the legislation imposed a ceiling on fees banks could charge on debit transactions, it is impacting banks in a way that is more like a tax. When companies are taxed, the burden of the tax gets shifted.
Corporate finance is not all that different than personal finances. To remain viable, your income needs to be more than your expenses. This is what is known as profit. While reducing debit card fee revenue isn’t likely to cause banks to have greater expenses than income, few individuals or businesses can handle a dramatic loss of income without major financial upheaval. That’s because we make plans based on our profit making history and a dramatic loss of income means a change in how we operate. Avoiding financial upheaval is the driving force behind a concept known as tax shifting.
Just because a tax is imposed on a business does not mean that the business will bear the burden of paying the tax. Businesses have a large number of stakeholders like customers and employees. Companies are usually able to shift tax burdens onto these parties when macroeconomic conditions allow.
The main driver of whether consumers will pay the burden of a tax is the price elasticity of demand for the product. Debits cards were more sensitive in price than banks thought and miscalculated how they could shift the burden of financial regulation. However, the reality is that banks will be able to shift these costs to others.
Jeremy of the Personal Finance Whiz pointed out this morning that banks could make small increases to a number of financial products. The idea being that spreading out the increases to a bunch of different products is more inelastic than a giant $5 debit card fee. We’ll have to wait and see, but there is a more likely option.
As the debit card fee failure showed, businesses may not be about to shift the burden of financial regulation on to customers, which means that it may fall on employees. The driver behind whether a company can shift tax burdens onto employees has to do with the condition of the labor market. With ample outsourcing opportunities, wage arbitrage and high unemployment, employees regularly take the brunt of these types of regulations. I suspect that it will be the case again.
Best Case Scenario
The optimal situation would be for banks to make up the lost income by financial product innovation. Debit cards and credit cards haven’t always been around, instead they are relatively new ways for banks to make money. By creating a new stream of income, banks would not need to pass lost income off to any group. However, innovation doesn’t happen overnight.
Banks could also simply absorb the loss of revenues and take much lower margins. However, as I said before, that would be the financial upheaval option.
So, while debit card fees are dead, consumers and bank employees are far from out of the woods. In fact, they are still likely to pay for the lost bank revenue.