Banks' newest game: Debit card fees

NEW YORK (CNNMoney.com) -- Could debit cards be the next cash cow for banks? If banks have their way, they will.

Americans have conducted more transactions and spent more money using debit cards than credit cards this year -- the first time that's ever happened.

Next year, consumers are expected to spend $1.64 trillion with their debit cards, nearly two-thirds more than in 2006, according to the payments industry trade publication The Nilson Report.

And there is no indication this growth is slowing down anytime soon. Not only are Americans increasingly reluctant to take on more debt, but banks are expected to become more stingy with credit cards once new federal legislation takes effect next year, which could make the debit card the preferred form of payment for many consumers.

This hasn't gone unnoticed by large and small banks, who are currently looking for ways to wring any extra dollars out of their business at a time of severe loan losses.

"Banks, just like airlines and local governments, are looking for fee income to fill the revenue gap," said Greg McBride, senior financial analyst with Bankrate.com.

What is shaping up to be an area of focus for lenders are loyalty or rewards programs for debit card users.

A concept that has long been associated with credit cards, increasing numbers of banks have looked to such programs as a way to generate more fees from consumers.

Atlanta-based lender SunTrust (STI, Fortune 500), for example, launched a tiered series of travel debit cards in June that allow consumer and business account holders to earn miles with Delta Air Lines.

Just this month, Wells Fargo (WFC, Fortune 500) expanded its Cash Back program, saying it would allow customers to apply their debit card rewards toward paying down their home equity loan.

And Minneapolis-based U.S. Bancorp (USB, Fortune 500), which has offered debit card rewards as early as 2002, announced last week it was now making its own FlexPerks program, which allows cardholders to earn travel, cash or merchandise rewards, available to many of its consumer and small business account holders.

"We do find our customers are very interested in earning something," said Lynn Heitman, senior vice-president for retail payment solutions at U.S. Bancorp.

Of course, consumers don't necessarily have to pay for the privilege of having, or using, a debit card. Or at least not upfront.

Rather it is merchants that foot the bill, paying anywhere from 1% to 3% of every sale for the privilege of accepting a debit or credit card as a form of payment.

But calls by retailers and small business owners to cap those charges have grown increasingly loud in recent months, prompting some members of Congress to propose legislation aimed at curbing so-called interchange fees.

Should such lobbying efforts prove successful, banks' debit and credit card business would only come under further strain.

Lenders are already feeling the pinch from new Federal Reserve rules issued earlier this month that restrict how they charge overdraft fees to consumers.

"The rules have changed for debit cards," said Gerard Cassidy, managing director of bank equity research at RBC Capital Markets. "What banks have to figure out is how to maintain revenue growth of this product under the new rules and conditions we have to operate under."

Banks, as a result, have little choice but to pick on the already squeezed consumer.

And pushing debit card loyalty programs might just be the most painless means of doing so.

Only half of the nation's banks have some sort of debit card loyalty program in place. At the same time, many consumers have already embraced such offerings, noting that they would have used their debit card to buy groceries or gasoline anyway to make their purchases.

Still, some experts argue that debit card loyalty programs just aren't worth it for consumers.

Not only do they have to pay an annual fee of as much as $55 in some instances, consumers also only benefit if they rack up some significant charges.

Under a typical debit card rewards program, for example, a consumer looking to earn a $100 credit towards an airline purchase would have to spend $33,333, according to research published by consulting firm TowerGroup.

That's not an easy feat for most Americans, notes Brian Riley, research director of bank card services for TowerGroup. The median annual income for a U.S. household stands at around $51,000, before taking into account taxes and housing costs.

"Every remaining nickel you spend will have to go on [your debit card], which is just not practical," he said.

Of course, not all rewards programs are a rip off, although it is rare to find one without some sort of a catch. Customers of East Coast lender Citizens Bank can earn 10 cents on every purchase with their Green$ense debit card, up to $120 a year -- although that means no more paper statements or notices about your account.

Checking account holders enrolled in Regions Financial's (RF, Fortune 500) CheckCard Rewards program may earn 4% cash back on music downloaded from Apple's iTunes store or airline tickets purchased online from Southwest Airlines. To maintain their account, however, customers are required to pay a $5 monthly fee, which can be waived if a customer uses direct deposit or receives their statements electronically.

"Consumers need to have an eyes wide open perspective when it comes to financial services," said McBride of Bankrate.com. "Fees are going to be cropping up, but that also gives you a chance to comparison shop. There may be just as many good deals at the other end of the spectrum."