H.R.4173. In a day when 140 characters rule the media, these six characters may usher in the third major era of the Debit industry.

To quote another famous H.R.:

Can’t do a little, ‘cause he can’t do enough

– H.R. Pufnstuff Theme Song, Sid & Marty Kroft

That may in fact be the bottom line here. H.R.4173 – Dodd-Frank Wall Street Reform and Consumer Protection Act is trying to do so many things, but even those may never be enough. The intent, I believe is fine:

To promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.

Tucked away in this 848 page bill (on page 693) is legislation that regulates Debit Interchange. As discussed here before, it does so by giving the Fed control over the Interchange amount:

The amount of any interchange transaction fee that an issuer may receive or charge with respect to an electronic debit transaction shall be reasonable and proportional to the cost incurred by the issuer with respect to the transaction.

…using the following criteria:

‘‘(4) CONSIDERATIONS; CONSULTATION.—In prescribing regulations under paragraph (3)(A), the Board shall—
‘‘(A) consider the functional similarity between—
‘‘(i) electronic debit transactions; and
‘‘(ii) checking transactions that are required within the Federal Reserve bank system to clear at par;
‘‘(B) distinguish between—
‘‘(i) the incremental cost incurred by an issuer for the role of the issuer in the authorization, clearance, or settlement of a particular electronic debit transaction, which cost shall be considered under paragraph (2); and
‘‘(ii) other costs incurred by an issuer which are not specific to a particular electronic debit transaction, which costs shall not be considered under paragraph (2); and
‘‘(C) consult, as appropriate, with the Comptroller of the Currency, the Board of Directors of the Federal Deposit Insurance Corporation, the Director of the Office of Thrift Supervision, the National Credit Union Administration Board, the Administrator of the Small Business Administration, and the Director of the Bureau of Consumer Financial Protection.”

Umm… OK. Reasonable Interchange will be determined by comparing it to check transaction clearing costs, as well as INCREMENTAL authorization, clearing, and settlement costs. Not value, mind you, or the subsidization this has to the overall DDA relationship required to conduct such a transaction.

You can guess that I think the calculation for this is far too simplistic. And I am not alone on that.

But instead of criticizing the obvious here, I think it is important for all players effected by this to examine what to do next. What are the impacts? How can the law be leveraged, or at least mitigated?

Let’s look briefly at each group:

RETAILERS

Retailers are the winners in all of this, hands down. They will receive the biggest cost savings (assuming that Interchange is lowered), and yet they are under no obligation to pass on these savings to the consumer.

Retailers will now have the ability to explicitly charge for debit transactions. Will they alienate their customers further by doing this, or will they take the Interchange savings and easy windfall? Additionally, retailers need to determine how payment mix may shift because of this, and how to best align themselves to maximize the shift.

ISSUERS

One of the losers here, they will no doubt feel the impact of reduced Interchange. Bank of America in its most recent earnings call identified a reduction of $1.8 billion to $2.3 billion per year. For just BofA.

The questions Issuers need to be asking themselves all revolve around value. If they are not getting sufficient revenue from Interchange on debit products, what products can they deploy to at least offset lost revenues with lower cost? Might traditional EFT Network PIN Debit be a better alternative to Signature Debit? Additionally, how willing are consumers to explicitly pay for products? Will we be forced to have annual fees for ATM/Debit cards? Will monthly fees for DDA accounts be reinstated, or at least the limits of free checking be increased?

Significant analysis and optimization will need to occur – and occur quickly, since this all goes into effect in nine months.

CONSUMERS

Debit card users are losers here. They will likely not see reduced prices at retailers. They will see fee increases from both banks and retailers. [Remember that BofA figure? That loss of $1.8 billion will need to be made up somewhere – most likely, in fees to accountholders.] What can they do?

Until Interchange is regulated on the Credit side, they should shift to a credit card with no balance. That, however, is a short-term play. Ultimately, this, too, will fall.

Therefore, consumers are going to be looking for new products that shift the payments paradigm (though, probably not Cash), or current products that are lower-cost for the banks to provide so that they can still offer them at a nominal price. But the consumers should be opportunistically looking for alternative payment options. Can mobile make a big play now? Is this the impetus?

PAYMENT NETWORKS

Market position impacts the questions networks should ask and the actions they should take. Visa and MasterCard Signature Debit pricing relies on high Interchange. How will the Net Economic Value to Issuers be challenged when that Interchange amount is regulated to equal to PIN Debit?

PIN Debit Networks need to look at this opportunistically and determine if now is the time to become the low-cost provider. Lower fraud and the single message system for authorization and settlement may finally let PIN Debit have its day.

Like the consumers, though, the networks should be looking for the next innovation that shifts the payments paradigm. And it is here that the new era in Debit really begins.

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