Dodd-Frank contained the so-called Durbin amendment which capped debit card fees that could be charged to merchants. And now banks are charging $5/month to card holders because
[A]s Jamie Dimon, chief executive of JPMorgan Chase, put it after passage last year of the Dodd-Frank Act, “If you’re a restaurant and you can’t charge for the soda, you’re going to charge more for the burger.”
But if you can charge for the burger, why weren’t you charging for it in the first place? There is a good reason why a bank could charge for the debit card: It is tied to a checking account and the cost of switching to a new bank will mean that the bank can get away with a small fee without much drop off in demand deposits. So to paraphrase Dimon:
“If you’re a restaurant and you can charge for a burger, you’re going to charge for it, whether the soda is free or not.”
Cheap Talk 
6 comments
Comments feed for this article
September 30, 2011 at 12:01 am
kerokan
I don’t understand how the consumers’ cost of switching explains the timing of BofA’s new fee. Why did BofA not charge for debit fees two years ago, when it was costly for consumers to switch?
September 30, 2011 at 12:02 am
Eric Gilson
That doesn’t sound quite right. Dimon is making an argument about the profit maximizing way to charge for separate elements in a bundle. Burgers and Soda a generally purchased together at a fast food restaurant. So in general the optimum way to charge for this bundle is a positive price on each Burgers and Soda. (Evidenced by the fact that all chains do it this way.) But is there is a constraint placed on this problem, say the price of Soda must be 0, the new optimum will be a higher burger price to discourage soda consumption as it is provided below cost.
This fits with the pricing for using cards. Instead of choosing the way to price a bundle of goods, it is looking to bundle prices for the same good. In this case using the card has a price on the holder, the monthly fee, and the merchant, the interchange fee. Before the legislation banks had determined that the optimal price bundle was no card holder fee and a high interchange fee. As evidenced by the shift towards fewer fees and more perks from banks over the past decade or so. With the change in laws, the banks now have a new constraint which binds changing the solution to the price bundle problem.
Dimon’s analogy is completely apt if a bit circuitous as he is comparing optimal pricing of a bundle of goods to the optimal bundle of prices for one good. Which are very related problems. Under the assumption that burgers and soda are always consumed in the same ratio, the only difference is the burger/soda example has 2 prices for the same consumer whereas the bank example has a price for each of two consumers. (In essence the banks were leveraging creating a negative externality on merchants by inducing consumers to use the card too often by making the consumer’s marginal cost of the card zero. This way they get more purchases and high fees from the merchants.)
(Yes there is an objection that the consumer ultimately pays the interchange fee due to merchants raising prices, depending on elasticities of course. Though this would imply that merchants will drop prices in response to this rule change. But given that the merchants where the interest group lobbying for this change I doubt that they will drop their prices implying that they pay the interchange fee.)
September 30, 2011 at 12:50 am
afinetheorem
Beyond the analogy, why isn’t the story about concentration in the banking sector rather the Durbin Amendment? Chase and BoA have massively increased their share in the banking sector over the past couple years (and not in the free market way). Both were known when I worked at the Fed for their consumer unfriendly practices – as far as I know, the ban on overdraft fees was a direct consequence of BoA’s shady practices like “biggest-to-smallest” payment ordering at the end of each day.
The overwhelming majority of banks and credit unions in the US do not charge for checking, do not charge for debit usage, do not charge (other than the visa %) for using foreign ATMs, and do not charge for using domestic ATMs out of their network. Indeed, there exist banks (like mine) that do all that and even pay the ATM fees incurred when using other bank ATMs. BoA and especially Chase have been harping for the past year about how this rule will make it impossible for them to offer free checking to those with low balances (and indeed, why should they bother when the Fed Funds is at 0%?). The debit charge strikes me, given earlier comments from Dimon, as a deliberate attempt to get consumers to call their representatives and complain about Durbin. Hardly any small banks and credit unions have made zero change in their fee structure.
September 30, 2011 at 6:47 am
Andrew
Eric is right. And he sounds like an Econ major.
September 30, 2011 at 7:55 am
Joshua Gans
Sandeep, its the regulatory change. That’s why. http://economics.com.au/?p=8030
September 30, 2011 at 9:34 am
Sandeep Baliga
Thanks, Josh and Eric. I knew there was something basic I was missing. Might be a good thing to teach MBAs.