Debit or Credit - What's the Difference?

Daniel A. Northway, Executive Vice President, Chief Financial Officer, Scott Valley Bank

Recently, an email sent by a customer to our “info” mailbox via the Scott Valley Bank website was forwarded to me for a reply. Our customer had been reading the news about Bank of America’s $5 monthly debit card fee and wondered if we were going to follow their lead.

I was happy to be able to answer the primary question in the negative – we don’t have plans to introduce a debit card fee – but there was more to this issue than a simple question about charging a fee for providing a debit card. Our customer wondered why there was a difference between processing debit and credit transactions, and if it would be “cheaper” for the Bank and for them if they used their card as a credit card.

This customer was aware that a debit card could be processed over either the debit or credit networks, and knew that the end result would be the same: funds would be electronically withdrawn from her checking account to pay for goods or services. She just didn’t know if there was an advantage to her or to the Bank if she selected one method over the other.

This topic has gotten considerable news in the past couple of weeks, and you can find tons of editorial comment in just about any newspaper. Here are some of the key issues from our perspective:

Debit cards are here to stay. They are a key convenience for our deposit customers, and they reduce the amount of paper checks that we have to handle. Both the customer and the Bank benefit from the use of debit cards.

We pay a fee to belong to various processing networks so that our debit card can be used at a large number of merchants.  In return, the merchants pay a fee for every transaction they clear through that network.  The owner of the network keeps some of that fee, and the bank issuing the debit card gets a piece.

Congress recently passed a law that limits the amount of fee that merchants have to pay for the transactions they run through the debit networks. When Congress set a limit for the debit fees, they thought this would result in savings for the consumer, but we haven’t seen evidence yet that the merchants (e.g., Wal-Mart) are passing that savings on.  It appears that merchants are pocketing all of the savings legislated by Congress, at the expense of the consumer.

For Scott Valley Bank, the fees we receive offset our cost to belong to the network, the cost of providing the cards, and the occasional fraud losses that we take on bad transactions.  The Bank incurs some differences in cost for credit network transactions as opposed to debit transactions, but that’s largely related to how disputed transactions are handled.

Debit card fees are a much bigger factor in the profits of the big banks, however, which is why they are being so aggressive about trying to make up the income elsewhere.  Then again, the big banks have to answer to hedge fund investors and Wall Street – we are family-owned and locally managed.

For a debit card holder, there is no difference in processing cost to use the credit network instead of the debit network.  Both networks move the transaction to your account electronically in much the same way.  Where they differ is in how they verify your identity – signature vs. PIN – and in the laws that apply to a disputed transaction.

Merchants still have to pay a higher fee for processing over a credit network than a debit network. Some of that has to do with history; back when Visa was known as BankAmericard, a credit transaction actually involved a loan made by the bank issuing the card. Some of that has to do with exclusivity: think American Express or Diners Club, which have their own networks only for their cards. As a practical matter, however, the differences between the two methods have been largely eliminated over the past several years.

As with any sweeping legislative change made to a widely-used financial product, the law of unintended consequences will undoubtedly come into play. Merchants may be willing to offer you a discount for a debit transaction, but I think it’s more likely that they will look for ways to charge you more for a credit transaction. Big banks might be more transparent about their processing costs and relate them to their fees, but I think it’s more likely they will look to create new products that get around the restrictions in order to make up lost revenue.

Scott Valley Bank will continue to provide high-quality service and competitive products at a fair price to its customers. Debit or credit? You should use whatever method you feel most comfortable with – we can handle either one.

Daniel A. Northway
Executive Vice President, Chief Financial Officer
[email protected]
Scott Valley Bank
View Scott Valley Bank - The Vault - October 2011