How Debit Card Fees Work Behind the Scenes and How Consumers Lose

Do you ever wonder how debit card transactions are processed? I never have, and I certainly never thought there was much of a difference between using the Personal Identification Number (PIN) function or signing the receipt. It turns out (unsurprisingly) that not only does it make a significant difference, but it's yet another one of the roundabout ways that Visa, MasterCard, and various banks sneakily utilize to separate you from your money.

When you go into Radio Shack (sorry - The Shack) or Carl's House of Chicken, swipe your Visa or MasterCard, and use the signature function, the store pays your bank on average of $0.75 for each $100 that you spend. This is almost double the amount that the store pays should you enter your four digit PIN on the keypad for the same transaction. To the person making the purchase, the transaction is identical whether you sign or use your PIN number, but the truth is their simple decision can in aggregate mean hundreds of millions of dollars of revenue for companies that lurk behind the scenes.

Despite the significant disparity in cost between the signature function and PIN function, signature debit cards are the preferred method of debit card use in the United States, accounting for about 61% of all debit transactions (numbers cited by New York Times article). So why is the signature function preferred when the PIN function is cheaper to stores and leaves the consumer less vulnerable to debit card related fraud? The answer lies in the difference in fees reaped by the "payment networks" (Visa and MasterCard are the largest) and banks that issued the credit card.

Visa and MasterCard act as gatekeepers for the entire network that debit cards are transacted over, and collect 5 or 6 cents on every transaction that passes through their networks, with the bank that issued the card keeping the rest of the fees. In addition to the per-transaction fees, banks that issues branded Visa or MasterCard debit cards also pay a licensing fee based on the amount of money that their cards generate.

The difference between a few cents might not make much of a difference to many small retailers, restaurants, or Mom and Pop shops, but the frequency of such transactions make a huge difference to retail giants like Home Depot or Wal Mart where millions of transactions happen. Both of those retail giants "encourage" customers as much as they can to use the cheaper PIN function. And wholesale club giant Costco won't allow you to use the signature function at all when you check out. You may be thinking "So What? I don't care what the banks or credit card companies do, as long as I don't have to pay any more." Well, you are. Stores aren't simply going to eat those costs, no matter how small, they're going to pass them along to you, the consumer. In fact that National Retail Federation estimated that these debit card fees cost the average American household approximately $427 during 2008 (figures cited here). That's a decent chunk of change.