One provision of the Dodd-Frank Wall Street Reform Act was supported by more than 200 trade associations representing businesses all across the country as well as more than 5 million individual Americans who signed petitions in support of reform. That provision, known as the Durbin amendment, passed overwhelmingly with the support of a bipartisan group of 64 Senators. The amendment required reform of the swipe fees (also known as interchange) that the nation’s largest banks charge when someone uses a debit card.These fees imposed on debit and credit cards are often the second largest operating expense for small merchants – more than rent and utilities and only less than labor. And these fees are the fastest growing expense for these businesses (growing much faster even than health care costs).

The Federal Reserve has now issued proposed rules to implement the amendment. Those rules will help ensure that the largest banks (those with more than $10 billion in assets) charge swipe fees that are reasonable and proportional to their costs. The rules will also promote competition among card networks. The amendment also allows merchants to start giving customers discounts. These are great developments for small businesses and consumers all across the country. Unfortunately, the large banks and card companies are continuing to spread misinformation about the amendment and the rule. This paper is designed to very briefly address some of the most frequently heard myths about this topic.

Myth: The Federal Reserve’s rule does not allow banks to recover the cost of their card programs .

Reality: Even the banks most critical of the rule admit that swipe fees are just one of many revenue streams that banks get on checking accounts. Banks don’t need to cover every cost they have for their entire business through swipe fees any more than a grocery store has to make all of their money from selling milk – there are a lot of other ways they make money.

Plus, the rule only limits swipe fees that are centrally fixed by card networks like Visa and MasterCard.If banks would just set their own prices rather than fixing them together, the rules wouldn’t apply. This is the right way to deal with the refusal of banks to compete on swipe fee prices.

The system ought to work like paper checks. The Federal Reserve has prohibited the equivalent of swipe fees on paper checks for nearly one hundred years. That has made the U.S. check system more efficient and ensured that the fees that are charged are transparent and competitive. (Both merchants and consumers pay other types of fees in the check system) Debit cards, which are just plastic checks, should operate the same way and the Fed’s rule is a move in that direction.

Myth: The Federal Reserve is setting prices.

Reality: The Fed rule proposes options including a safe harbor and/or a cap based on banks’ costs. Under the safe harbor, banks could set their fees in relation to their costs as long as they can back it up – or they could choose to use the safe harbor. The Fed’s cap is like an usury law setting the limit on what is reasonable.

And, as noted above, the rule only applies to fees that are centrally fixed by card networks today. Banks are free to charge what they want if they don’t fix prices.

Myth: The Federal Reserve’s rule would hurt small banks and credit unions.

Reality: The rule will help these small institutions compete. Today, most debit swipe fees go to a handful of giant banks. The fees are incredibly profitable for them because they have economies of scale. Overall, the profit margins on these fees are about 60 percent. The fees are less profitable for small banks. This disparity hurts small banks because big banks use the extra money to market themselves and get more business from their small competitors. The disadvantage is locked in by the system of centrally set interchange whereby all banks charge the same thing.

The Fed rule exempts every bank and credit union with less than $10 billion in assets from the requirement that swipe fees be reasonable. That means about 99 percent of banks will be exempt and can for the first time charge higher fees than their large competitors – which will help them compete with the huge banks and even the competitive playing field.

Small banks and credit unions have argued the card networks will lower the interchange fees they receive despite the exemption. However, Visa has affirmed they will support a two-tiered interchange system, which means interchange fee revenue will not change for those small banks and credit unions. In a January 7th emailed statement a Visa spokesman said, "We expect to have a separate rate schedule for exempted institutions and products at the time of implementation" of the Fed's rules. According to one payments consultant, initial reports that Visa would not support a two-tier system was “simply intended to scare credit unions and small banks to keep them lobbying.”

Myth: The Rules don’t take fraud costs into account.

Reality: It is important to understand that while banks complain about the costs of fraud on card transactions, they charge merchants for more fraud losses than they absorb. That’s right, while the banks talk about a supposed “payment guarantee” for merchants, they don’t guarantee anything. If there is fraud, most of the time the merchant pays for it.

Not only that, the Durbin amendment and the Fed rules do provide ways for banks to recover their costs for preventing fraud. Merchants have huge costs of preventing fraud (and covering for losses), but the rules still allow an avenue for banks to recover costs that are justified and legitimately help by reducing fraud in the system.

Myth: Requiring banks to connect to more than one network is difficult and expensive .

Reality: It has been standard in the industry for years for the banks to allow their debit cards to be carried over multiple networks. The change by which Visa and others aggressively paid banks not to do this is relatively recent and has hurt competition in the industry. Banks typically connect to networks through providers who already connect to every network. Turning on additional networks is cheap and easy, and should not require the re-issuance of any cards. Ensuring that exclusive deals that prevent competition go away is good policy and will allow smaller networks to compete for market share and new entrants to grow.

Myth: Merchants won’t pass on savings to consumers.

Reality: The big bankers have been relying on these fixed fees for so long that they no longer believe in America’s system of competitive capitalism. The U.S. economy, and standard economics, show that when business costs go up, prices go up and when business costs go down, prices go down. The only time this doesn’t happen is when there is some antitrust problem that prevents it (as with swipe fees).But American retail is intensely competitive and is one of the great success stories of any modern economy. Profit margins are very narrow year after year (between 1 and 3 percent). Merchants have to pass on savings to customers in order to compete and there is no doubt that will happen here. Declining consumer prices for products as diverse as computers, flat screen televisions, and more demonstrate that lower business costs mean lower prices. Studies from organizations as diverse as the Department of Energy (on gas prices), Reserve Bank of Australia, and the Hispanic Institute all demonstrate that when costs go down for merchants, those merchants pass on savings to their customers.

Myth: This rule will end free checking.

Reality: This is a scare tactic. It is now proven that the card companies used just such a scare tactic to try to get small bank opposition to this idea and now they are trying to scare consumers. Here is the truth:

The banks started talking about charging consumers more fees and ending free checking two years ago because of bad market conditions that the banks themselves created. Then the banks started saying they would charge consumers more fees on their accounts because of the 2009 Credit CARD Act. Now, they are blaming it on the Fed rule. Many banks have already started charging more and did even before the rule was ever proposed. The rule won’t be in effect until next summer. So what is going on? Blaming this rule is just an excuse for the banks to try to avoid criticism for raising fees – and lobby against policies they don’t like at the same time. The bottom line is that banks would move consumer fees up as much as they can to maximize profits based on market conditions even if this rule disappeared tomorrow. The proof of that is the fact that swipe fees on merchants have tripled just since 2001 while the banks have continued to raise consumer fees too.

Consider how the free market and competition work. If a large bank decides to end free checking, a customer will look to his/her community bank or credit union that still offers free checking (remember, they are still collecting full interchange on debit, and according to the banks, this is what allows free checking).Just like if a gas station decided not to accept credit cards at the pump. Customers would go to the competition that still offered pay at the pump.