Bank Reforms: Consumer Protection Comes at a Cost

A congressional conference committee agreed Friday on a package of reforms for the financial services industry that contains some key new protections for consumers. But before the celebrations even begin, bank customers may get hit by bigger fees.

The bill has two main provisions that affect consumers, rather than big banks, which were the focus of the main legislation. One, it provides for the creation of a new consumer financial protection bureau, which will take on the functions of half a dozen disparate federal agencies in writing rules for virtually all financial transactions, including credit cards and mortgages.

Two, the legislation also adopts new rules for debit cards, which will reduce the costs merchants pay to banks to process debit card transactions. Those fees, totaling about $48 billion a year, will now be set by the Federal Reserve, but will be based only on what it costs the banks to carry out a transaction, not a percentage of the total charged, as is the case presently.

Tough Consumer Protection Rules

The compromise bill still needs to be submitted for a vote in both houses of Congress. It will go to a vote in the House of Representatives next Tuesday, to be followed two days later by adoption by the Senate.

President Obama said the bill contained the "toughest" consumer protection rules in the country's history. "Credit card companies will no longer be able to mislead you with pages and pages of fine print," Obama said. "You will no longer be subject to all kinds of hidden fees and penalties, or the predatory practices of unscrupulous lenders."

But it's becoming clear that those protections will come at a price to consumers.

Higher Fees to Consumers 'Inevitable'

Steve Verdier, director of congressional affairs for the Independent Community Bankers of America, or ICBA, which represents 5,000 banks with assets under $1 billion, says the bill will inevitably result in higher fees to consumers.

He says that most retail bank customers have been traditionally offered a free debit card along with their checking accounts. The costs of the account have been paid by "interchange" fees paid by merchants for processing debit card transactions. But that's about to change dramatically.

"Because that income to the banks is going to be shaved down to next to nothing, banks are going to have to make up that income, and they will have to charge that cost directly to the customer," Verdier says. "Up until now, merchants had paid a lot of that cost, and they aren't going to pay it anymore, so somebody has to pay it -- and it's going to be the consumer."

Verdier says that a separate decision by the Federal Reserve to limit overdraft charges to $25 per transaction also reduced banks' income on retail accounts. "Consumers will find that banks will go back to charging for maintaining a checking account or requiring higher minimum balances," he says.

At an average monthly cost of $9, that could cost consumers around $108 a year.

Some Savings Passed Along to Consumers

Adam J. Levitin, a consumer advocate and an associate professor of law at Georgetown University, argues that a reduction in debit fees will benefit all consumers because merchants simply add the debit card costs to all bills, not just those of debit and credit card users. Some of those savings will be passed along to consumers, he says.

The bill allows merchants to offer discounts to customers who use cash or debit cards rather than credit cards, which charge merchants higher interchange fees than debit cards. But Levitin says a significant change was that merchants won't be able to discriminate based on credit card brand, so they can't charge more for a Visa card than a MasterCard.

Consumer advocates had hoped that allowing discrimination would have introduced competition in the closely controlled market for credit cards by encouraging new entrants to undercut the established players.

Levitin says consumers will also save money thanks to the creation of the new consumer financial protection bureau, which will have the ability to force lenders to explain their products in simple language. Many consumers have complained that they were confused by complex terms for exotic mortgages and ended up paying far more than they had been led to believe.

"Because billing tricks and traps are hidden costs, if you have transparency in pricing, you have better price competition, and that means lower costs for consumers," Levitin says.

Impacts on Smaller Banks

But Verdier says the bureau could cause banks' expenses to rise as they hire staff to deal with new rules.

"An agency devoted to consumer regulations will inevitably ratchet up the level of regulations, and whether these are justified or not, the fact is they will increase the compliance costs that a community bank has to meet, and those costs will be passed on," Verdier says.

In fact, the American Bankers Association issued a statement Friday saying the possibility of new consumer protection rules could have a negative impact on smaller banks. "Many small banks are telling us they will simply have to sell out to larger institutions that have the staff to deal with the massive volume of new reports and rules," the ABA said.

While the key measures will reduce banks' revenues, the bill also provides for a $4.3 billion savings to smaller banks. It reduces the amount small banks pay for federal deposit insurance and raises the fees paid by larger banks.

"That will help offset some of these higher costs," Verdier says.