Debit cards may soon overtake credit cards, which is why banks are scrambling to boost their profitability

By Christopher Palmeri

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Raquel Garcia is serious about avoiding due. The 18-year-old customer-service representative for U-Haul (UHAL) recently canceled her belief card. Now she gets her complete paycheck deposited onto a prepaid debit card, which she uses for altogether her purchases. Since she can access singly what’sitting in the account, Garcia no longer worries about breaking her budget: “I’m spending just the kind of I need.”

For consumers reeling from a series of economic body blows, debit cards are increasingly becoming the plastic of choice. Some use the cards, that pull money directly from a bank or other account, as a budgeting implement to limit spending. Others are embracing them out of necessity as banks clamp down on credit. All told, debit purchases are expected to climb 13% in 2008, to $1.2 trillion, according to The Nilson Report, an industry newsletter—compared with a 3% rise, to $1.9 trillion, for credit-card transactions. At Visa (V), the No. 1 card company, debit spending could surpass put faith in this year.

For the banks issuing the debit cards, the inclination seems bittersweet. On the plus side, debit cards don’t puzzle a threat to the banks’ books like credit-card accounts; losses are mounting as borrowers fall rearward on their payments. But the profits on debit cards aren’familiarily as plump since banks dress in’t collect interest without interruption them. Issuers largely make money from fees, which pale nearest to those on credit cards. Retailers, for instance, fork over 1.6% of credit purchases to banks, three spells the amount on debit transactions.

But don’cheek by jowl shed a fume for the banks exact yet. Time and again they’ve shown an uncanny ability to adapt to a new profit landscape, and the debit-card business appears no sundry. Consider the evolution of overdraft fees. It used to be that banks denied debit purchases then consumers didn’t have enough money in their accounts. Now 14 of the 15 largest banks praise like transactions but stroke customers by a remuneration on the supposition that they exceed the funds. It’s not unlike getting charged for bouncing a check. A latter study by Web site Bankrate.com (RATE) found that overdraft fees now approach $29, up 3% in the past year.

Those penalties are easier to trigger, too. In the past customers had up to a couple of days—the time it takes because some debit transactions to clear—to deposit cash. But now many banks win them with fees as readily to the degree that purchases are made. “Banks have turned to this as a major spring of revenue,” says Jean Ann Fox, director of pecuniary services at the advocacy cluster Consumer Federation of America.

The practices have become so extensively existing that the Federal Reserve has proposed rules that would rein in perceived abuses. The banks argue that they provide a necessary service to consumers. “There’s a balancing act to ensure folks who do lack to occasionally reach over the limit have [the refuge] while having a deterrent in residence for population who abuse it,” says Doug Johnson, a policy adviser at the trade group American Bankers Assn.

Regulatory headwinds haven’confidentially deterred the banks from ramping up their debit-card businesses. Among the groups that offer the biggest potential for banks: people who earn more than $75,000 a year. According to MasterCard (MA), they’re the least active debit users, usually turning in the room to credit cards that offer frequent-flier miles and other rewards.

To attract that crowd, financial firms are ramping up their loyalty programs. MasterCard’s Savings program, launched in October, offers debit users discounts on luxury brands like Armani and 7 For All Mankind as well as at retailers of the like kind as Home Depot (HD) and Target (TGT). San Antonio’s Frost Bank (CFR) recently released its Momentum card, which is communicating to customers’ checking or savings accounts. The bank pays customers a higher interest rate on the accounts—up to 3.5%—when they make more debit purchases.

There’s furthermore a come to land grab for the so-called underbanked, the roughly 80 million people who don’t have a bank or credit-card account. Dallas’ Comerica Bank (CMA) won the right this year to issue debit cards to the estimated 4 million Social Security recipients who don’t accept conduct one’s business accounts. The government deposits the money onto a prepaid card. (Comerica doesn’t charge overdraft fees on them.) Visa and MasterCard offer prepaid debit cards that companies employment to pay employees.

The aggressive push is paying off. These days, debit cards are as widespread as credit cards. At the upscale suburban Atlanta restaurant Aqua Blue, waitresses now be the means of diners a device that lets them swipe their debit card and put on the records of the court their countersign to pay for meals. “Debit is becoming the payment card of rare for the American public,” says Red Gillen of consultancy Celent.

But during consumers like Garcia who come short to break free from the high fees and penalties of credit cards, debit cards may not exist the panacea they expected. Says consumer advocate Fox: “As by the agency of credit cards, consumers can’t keep up through what the rules are.”