Merchant acquirers might be breathing a sigh of relief following the Federal Reserve Board’s proposal to cap debit card interchange rates at 12 cents per transaction. But though the proposed rules would not directly affect them, issuer reaction might, observers say.
Interchange fees go only to the issuing banks, so ISOs and acquirers will not face a direct impact from the proposed rule, assuming it goes into effect next year as written, says Nicholas W. Baxter, senior vice president of First National Bank of Nebraska Inc. and a past president of the Electronic Transactions Association, a Washington, D.C.-based merchant acquirer association.
The Fed could alter the proposal between now and its expected enactment in July.
“The rate at which interchange is charged is not going to have a direct impact on our revenue stream,” Baxter tells ISO&Agent Weekly. “This is specifically true of merchants who operate in an unbundled pricing model, where interchange is a direct pass through.”
Acquirers collect interchange fees from merchants and pass the cost on to their merchant customers as part of the discount rate, which tacks on processing and other fees. The acquirers then uses a portion of their discount fee revenue to pay their ISOs, which typically manage the merchant accounts.
ISOs and acquirers generally use one of two pricing models. Bundled pricing typically has three rate categories: qualified, mid-qualified and non-qualified, with ascending rates. Unbundled, or pass through, charges the merchant the processor’s rate plus a transaction fee.
Sometimes a change in interchange rates causes some merchants to switch to pass-through pricing, Baxter says, acknowledging the difficulty in finding verifiable statistics to back that assumption. “But the perception is that this is the result,” he says.
Whether that will happen in this instance is uncertain. Indeed, the ETA, which canvassed its membership this week to gauge their positions on the Fed’s proposal, said in a statement the proposal will “make fundamental changes in the way debit card transactions are priced at the merchant level as well as the way transactions are routed.”
But the proposal raises many questions, the ETA said. “It will take some time to understand the full implications of those changes,” the organization said in its statement.
Short Term Win
If enacted as written, the rule could have a positive effect on acquirers, says David Fish, senior analyst at Mercator Advisory Group Inc., a Maynard, Mass.-based consulting firm.
“I’m a little surprised there was nothing in the draft rules indicating acquirers need to pass on their savings from reduced interchange,” Fish says. “This could be a huge win for merchant acquirers, at least in the short term.”
There is some precedent for this type of situation. Following merchants’ successful fight in 2003 against Visa Inc. and MasterCard Worldwide’s signature-debit rates in the so-called Wal-Mart class-action suit, large merchants were best positioned to benefit, while smaller ones doubted their ISOs or acquirers would pass along the reduced costs.
Acquirers also may see eroding debit-payment revenue, depending on issuers’ long-term reactions to the rules, Fish adds.
“The regulation could erode the value proposition on the issuing side so that the whole debit card industry is just reduced in size,” he says. “Issuers could make disincentives that would make debit cards unattractive to consumers.”
General purpose prepaid cards or hybrid prepaid/credit cards could increase in use, Fish says. “That is going to be a gradual change,” he predicts.
Concerning bundled and pass-through pricing, sometimes known as interchange plus, more time is needed to understand the impact from the Fed’s proposal, Fish says.
“I’m not sure bundled pricing is going to last,” he says. “We may see that interchange plus is going to be required.”
In any case, acquirers will have to examine their pricing rationales in the wake of this regulation, Baxter says.
“Whatever happens in the final rule, acquirers are going to have to closely examine their assumptions on interchange for bundled merchants specifically, but also their reporting and billing systems for handling those merchants who get pass-through interchange,” Baxter says.
Already, one ISO, McLean, Va.-based Sage Payment Solutions, is urging merchants to consider alternative payment schemes, such as gift and loyalty cards and mobile applications.
“It’s more important than ever that small and midsized businesses look progressively at their payments environment so they can quickly adapt to new marketplace realities as they occur,” Greg Hammermaster, Sage president, said in a statement.
Drew Freeman, president of Merchant Data Systems Inc., a Miami Beach, Fla.-based ISO, plans to wait and see what the Fed’s final rule is. But for now he is concerned that this may not be the last of the legislative action affecting the payments industry.
“My concern is eventually they’ll regulate everything,” Freeman says. “I like the market to set the price.”
Freeman also is frustrated that regulators do not appear to understand the industry. “It’s unfortunate the government seems to view debit [transactions] as exactly like cash,” Freeman says. “Setting caps is never a good idea.”