Card issuers’ potential losses from impending debit-interchange legislation could range from as low as $5 billion to more than $10 billion annually, a PaymentsSource analysis based on industry observers’ projections shows.
Initial estimates are broad because the Federal Reserve Board would have to consider a host of factors in determining the “reasonable and proportional” cost of debit interchange in accordance with a provision Congress is expected to approve within the financial-reform bill.
Observers speculate that sometime next year the Fed may introduce new interchange rates that are 25% to 75% lower than present levels. The pending legislation requires the Fed to issue its interchange regulations within nine months of the reform bill being enacted, and the new rules would become effective 12 months after the bill is signed into law.
A snapshot of the debit market suggests that if the Fed halves debit-interchange rates, Visa Inc.’s debit card issuers alone could lose more than $4 billion per year. That figure assumes a blended PIN/signature debit interchange rate of 0.09% and is based on the $925 billion in debit sales volume Visa reported for the 12 months ended March 31. Visa’s sales data include both signature-based check card and PIN-based Interlink purchases.
MasterCard Worldwide claims about 25% of the overall debit market, with $327 billion in debit card purchase volume in 2009. MasterCard’s data include volume from all electronic funds transfer networks whose brands also appear on debit MasterCards.
Merchants pay approximately $20 billion annually in debit-interchange fees across all card brands, according to a spokesperson for the National Retail Federation.
The Fed could cap debit interchange at a rate within a relatively broad range, says Sanjay Sakhrani, an equity analyst with New York-based Keefe, Bruyette & Woods. “It is not clear yet how much the Fed might cut debit-interchange rates, which makes it difficult to estimate the effect on individual issuers,” Sakhrani says.
Factoring in the various debit-processing costs that comprise interchange, including “incremental costs” and fraud, leaves “a lot of wiggle room,” he says.
The Fed’s new debit-interchange rates almost certainly would drive down signature-debit rates, says Steve Mott, a principal at BetterBuyDesign, a Stamford, Conn.-based payments consultancy. Fraud costs associated with signature debit are about twice that of PIN-debit transactions, he says.
Issuers are liable for transactions on lost and stolen signature-debit cards, while customers may repudiate PIN-debit transactions only when merchant fraud is involved or items are not delivered, according to Mott.
Moreover, Visa in recent months has increased PIN-debit rates, in some instances to near parity with signature debit, a trend that is likely to draw regulators’ scrutiny, Mott says.
“There is no justification for a sustained increase in PIN-debit interchange rates. ... One would expect much of those increases to be rejected as not cost-based,” he says.
Most issuers do not disclose how much they earn on signature debit compared with PIN debit, but PIN-debit’s share of the pie is growing, Adil Moussa, an analyst with Aite Group, tells PaymentsSource.
“We don’t have clear numbers on how much signature debit brings in versus PIN debit, but interchange is a big enough component on consumer-debit accounts that it finances a lot of other bank operations,” he says.
A cut of 50% or more in debit interchange likely would force banks to add fees for more services, possibly including charging customers for maintaining checking accounts with debit cards, Moussa says.
Gary Jewell, executive vice president of Baltimore, Md.-based Carrollton Bank, which operates as both a merchant acquirer and as a Visa check card issuer, says his institution makes no money on PIN debit, so his bank encourages cardholders to use their signatures instead as a way of generating “important” non-interest revenue.
Most banks already are bracing for a sharp decline in debit-overdraft fee income from new rules that take effect in August as part of the Credit Card Accountability, Responsibility and Disclosure Act, Jewell notes. An additional cut in debit interchange is a “double hit” to issuers’ revenue. “Revenue is going to drop like a brick,” he says.
“They're already talking about no more free checking, and that’s just to make up for the overdraft fees they will lose,” Jewell says. “Somewhere along the line banks will look at that and say ‘we lost millions of dollars in revenue. How do we make that up?’”
PIN-debit, which accounted for about 30% of all debit transactions through 2008, now comprises “about half” of all debit, says William Shaw, group vice president of the 390-branch Roanoke, Va.-based First Citizens Bank. The bank functions as both a merchant acquirer and as an issuer of credit and debit cards.
“PIN-debit doesn’t really bring in any interchange revenue,” Shaw said. While signature-debit rates are as high as 1.35%, the combined costs of marketing plus supporting debit-rewards programs consume approximately 60% of signature-debit revenues, he says.
“We’re going to see a big drop-off in signature-debit programs when debit-interchange regulation comes through,” Shaw says.
The debit-interchange rules specify that the Fed will not directly regulate network transaction fees Visa and MasterCard charge banks. These fees, which the networks negotiate with banks, vary.
It is too early to speculate whether Visa’s or MasterCard’s operations might suffer if issuers pull back on debit card programs because of lower interchange rates, Sakhrani says. Visa’s total debit transactions grew 39% during the 12 months ended March 31, to 29.9 million from 21.5 million a year earlier. Total debit transactions initiated with debit MasterCards in 2009 increased 10.6%, to 8.3 million in 2009 from 7.5 million the previous year.
Discover Financial Services might see a reduction in debit-interchange revenue through its Pulse PIN-debit brand if the Fed cuts PIN-debit rates, Sakhrani says. American Express Co., which does not operate a debit card network, would be unaffected.
Despite the loss potential of revenue, it is unlikely lower interchange rates would deter banks from promoting debit card use. In fact, it might have the opposite effect.
“The only way to make that up is to get [cardholders] to use their cards more,” Carrollton’s Jewell says. “That is a substantial amount of income for us.”
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