Why Do People Use Debit Cards: Evidence from Checking Accounts

I. INTRODUCTION Debit card use has grown faster than any other payment instrument in the United States. A minor segment of the market used debit cards in 1998. However, Figure 1 shows that because of rapid growth in their use, more transactions are made with debit than with credit cards. The puzzle of debit's popularity is that explicit costs appear to favor credit over debit. With debit, money immediately comes out of the bank account, whereas with credit, the household is billed for purchases at the end of the month and pays within a further grace period. As long as no balance is carried on the credit card, the consumer pays no interest. This float may be minor if evaluated at a savings account interest rate; however, for liquidity-constrained households, the opportunity cost--payday loans or bank bounce protection--is quite high. Credit cards also offer the option to convert the balance into an uncollateralized loan with zero transaction cost. Most credit cards offer rewards (cash back, airline miles, gift certificates, warranty on purchase, charitable donations, etc.) or a below market interest rate. Only 5.7% of banks offer rewards on their signature debit cards (Moebs Services Inc. 2006) and some financial institutions (15%) charge a fee for PIN debit purchases, ranging from 10 cents to 2 dollars per transaction. The goal of this paper is to investigate the factors that have caused a seemingly dominated product to become a market leader. Consumer debit card choice has implications for monetary policy as such choices affect money demand and money transmission mechanisms. With $894 billion in credit card debt at the end of 2009 and 1.4 million personal bankruptcies in 2009, Americans' ability to effectively manage personal finances can have a strong effect on standard of living. As payment card networks exhibit network externalities, market concentration and its suppressive effects on competition is of concern to antitrust regulators. The extent to which these network externalities exist is dependent on the degree of substitutability of competing payment media. Survey evidence such as found in the studies of Zinman (2009), Stavins (2001), Borzekowski and Kiser (2008), and Borzekowski, Kiser, and Ahmed (2008) offers several motivations for choosing debit over credit: cost, convenience, merchant acceptance, time at checkout, purchase tracking, safety, being credit constrained, and spending restraint. Zinman notes that up to 31% of households could use debit for self-restraint. Uniquely, we use household transactions level data, a course of action recommended by Zinman. The sufficiently rich data are consistent with spending control, purchase tracking, merchant acceptance, and pecuniary motives (paying interest when revolving a credit card balance) as an explanation for some households' debit use. [FIGURE 1 OMITTED] Much of the growth in debit card use has come at the expense of checks or cash. From 1995 to 2003, electronic payments grew from 23% to 55% of all payments. Borzekowski and Kiser (2008) find that the closest substitutes for debit are cash, checks, and credit in that order. However, the debit versus credit comparison is quite clean (debit and credit equate in many dimensions considered by Klee 2006) and recently available data to track debit transactions as opposed to the anonymity of cash. However, with ATM withdrawals observable, we are able to compare debit and credit to cash. To speculate whether debit card use might be correlated with spending control motives, we look for evidence that debit card users are paying down a credit card balance. The checking account data contains credit card payments but not credit card balances. While the data do not contain full information about credit card balances, they do contain payments to credit cards. This is enough information to show that debit users are more likely to pay the same amount in multiple months, a sign that they are paying a credit card balance. …