Outside the Beltway

Debit Cards Poised To Overtake Credit Cards

Dodd Harris · Friday, October 31, 2008 · 6 comments

According to Business Week, money spent by means of debit cards could surpass credit card transactions this year as consumers seek to avoid the fees and costs of credit, not to mention the increased difficulty of getting credit in the first place. This has banks scrambling to figure out how to profit from cards that don’t pay interest and generally have lower fees.

On the plus side, debit cards don’t pose a threat to the banks’ books like credit-card accounts; losses are mounting as borrowers fall behind on their payments. But the profits on debit cards aren’t as plump since banks don’t collect interest on them. Issuers largely make money from fees, which pale next to those on credit cards. Retailers, for instance, fork over 1.6% of credit purchases to banks, three times the amount on debit transactions.

But don’t shed a tear for the banks just yet. Time and again they’ve shown an uncanny ability to adapt to a new profit landscape, and the debit-card business appears no different. Consider the evolution of overdraft fees. It used to be that banks denied debit purchases when consumers didn’t have enough money in their accounts. Now 14 of the 15 largest banks approve transactions but hit customers with a fee if they exceed the funds. It’s not unlike getting charged for bouncing a check. A recent study by Web site Bankrate.com found that overdraft fees now approach $29, up 3% in the past year.

Not that they don’t want the business. In fact, they’re actively promoting debit cards to both ends of the income spectrum:

Among the groups that offer the biggest potential for banks: people who earn more than $75,000 a year. According to MasterCard, they’re the least active debit users, usually turning instead to credit cards that offer frequent-flier miles and other rewards.

To attract that crowd, financial firms are ramping up their loyalty programs. MasterCard’s Savings program, launched in October, offers debit users discounts on luxury brands like Armani and 7 For All Mankind as well as at retailers such as Home Depot and Target. San Antonio’s Frost Bank recently released its Momentum card, which is connected to customers’ checking or savings accounts. The bank pays customers a higher interest rate on the accounts — up to 3.5% — when they make more debit purchases.

There’s also a land grab for the so-called underbanked, the roughly 80 million people who don’t have a bank or credit-card account. Dallas’ Comerica Bank won the right this year to issue debit cards to the estimated 4 million Social Security recipients who don’t have bank accounts. The government deposits the money onto a prepaid card. (Comerica doesn’t charge overdraft fees on them.) Visa and MasterCard offer prepaid debit cards that companies use to pay employees.

It stands to reason that debit cards become more popular in the current environment. That the banks will find ways to squeeze more out of them is equally inevitable.