* Small banks fight debit fee limits despite exemption
* Visa, MasterCard said to pressure small banks into fight
* Card industry mobilizes to defeat U.S. Senate proposal
* Proposal threatens up to 75 pct of debit fees
By Maria Aspan
NEW YORK, June 15 (Reuters) - Small banks believe they have no choice but to support Visa Inc (V.N) and MasterCard Inc (MA.N) in a battle against lawmakers over fees for processing debit card transactions.
The alliance is an unlikely twist in a months-long fight between lawmakers looking to limit merchants' fees and credit card networks trying to protect their revenue. But the support of small banks could be enough to help block the provision, experts said.
At stake are billions of dollars in payments known as interchange fees, which merchants pay to banks and networks like Visa and MasterCard every time a customer pays for goods with a debit or credit card.
Lawmakers and merchants say that Visa and MasterCard unfairly exploit their duopoly. Interchange fees in the United States are among the highest in the world, in part because many other countries have regulated those fees.
The financial reform bill now wending its way through Congress has a provision that would reduce interchange fees for debit card purchases by as much as 75 percent, a banking trade group says. The provision would not directly restrict credit card interchange fees.
The big potential drop in revenue from the debit card proposal has jolted Visa and MasterCard into action, spurring them to lobby for the provision to disappear. The two companies process about 80 percent of the world's electronic transactions.
The law explicitly exempts banks with less than $10 billion of assets, so smaller banks in theory should not oppose the law.
But the exemption is cold comfort to small banks, which say that whatever the law stipulates, Visa and MasterCard will force them to accept the same fees as larger banks.
"Legislating a carve-out doesn't make it so," John Blum, the vice president of operations at the Chartway Federal Credit Union in Virginia Beach, Virginia, said during an online teleconference last week.
"We don't believe (the carve-out) will be necessarily applied" by Visa and MasterCard, Blum added.
Visa and MasterCard have "probably not directly" told small banks that they will receive lower fees, said Jason Kratovil, the vice president of congressional relations for the Independent Community Bankers of America, the primary trade group for small U.S. banks.
But it is "pretty clear, at least for our guys, that it's going to end up with one rate for all issuers," he said.
Either way, gaining the support of small banks is good news for Visa and MasterCard, experts said, because although large banks are often accused of triggering the financial crisis, many Americans view small banks as victims.
"It's good politics in this day and age to wrap yourself in the mantle of the small guy," said Jeffrey I. Shinder, a managing partner of the New York office of Constantine Cannon LLP and a longtime advocate for interchange reform.
Having the support of small banks may change the narrative of the fight between lawmakers and credit card companies to being a fight against government and the little guy, he said.
But lawmakers and others reckon that if small banks are supporting Visa and MasterCard in this fight, it's only because they were coerced.
"It appears that in an effort to frighten small banks and credit unions into opposing the amendment, your companies are threatening to make changes to your small bank interchange fee rates," Senator Dick Durbin wrote in a letter to Visa and MasterCard. [ID:nN27133310]
MasterCard and Visa say that lower fees will make it harder for them to invest in their networks, and that it will be difficult to apply separate fee structures to different banks.
"It is simply impossible to fundamentally alter the economics of a global network without altering the costs these smaller institutions would incur to operate their programs," MasterCard Chief Executive Robert Selander said in a letter responding to Durbin on Monday.
Visa spokesman Will Valentine said small banks and credit unions have "reached their own conclusion that the Durbin Amendment will harm consumers, will raise costs, and will make it difficult for smaller financial institutions to compete."
There are nearly 8,000 banks in the United States. Most of them are community banks and credit unions, but banks with assets of more than $10 billion have about 80 percent of the country's banking assets.
Merchants and bankers have long clashed over interchange, with the banking industry calling it the cost of doing business and merchants protesting their limited ability to negotiate the rates they pay for accepting plastic payment.
Merchants' trade groups estimate that their members paid $48 billion in interchange fees in 2008, up from $42 billion in 2007.
That amounts to one of the top expenses at some retailers. Home Depot Inc (HD.N), for example, said in 2009 that it pays more for interchange, its third-highest operating cost, than for employee healthcare.
The United States has some of the highest interchange rates in the world. At the same time, card industry watchers have criticized the United States for being slow to adopt new technology that could reduce processing costs and increase security.
For example, U.S. banks and card companies have resisted a switch to chip-based cards, which are more fraud-resistant than the magnetic-stripe system.
What's at stake for Visa and MasterCard is a lot of money: Visa had net income of $2.35 billion in the fiscal year that ended Sept. 30, 2009, and MasterCard had net income of $1.46 billion in 2009. Both companies are publicly traded, and concern about the Durbin amendment has lopped billions of dollars off their market values.
Bankers fear that the amendment would open the door to further reducing their credit card profits. The credit card industry fears regulation of its interchange fees, which accounts for almost a fifth of lenders' annual credit card revenues.
"Once that door is opened on debit interchange, it becomes a much smaller step for regulating other interchange, including credit card interchange, which is a much bigger fish," said Duncan Douglass, a lawyer with the firm of Alston & Bird who specializes in payment law. "That's Pandora's Box from the industry's perspective." (Reporting by Maria Aspan, editing by Dave Zimmerman)