The largest U.S. card issuers could lose more than $2 billion annually in debit card-related revenues from the combination of new regulations cutting into overdraft fees and pending debit-interchange regulation, according to a new report from Javelin Strategy & Research.
These reductions likely will force card issuers to search aggressively for replacement revenue, at least in the short run. Issuers are likely to step up their marketing of reloadable prepaid debit cards, which are exempt from the new rules, to generate reload-fee income, Javelin says.
Issuers also are likely to boost offers to lure back their more-lucrative credit card customers who switched to using debit cards during the recession, Javelin says.
But such strategies may be fleeting, as it is almost certain that during the present “environment of enthusiastic regulation of the payments industry,” prepaid cards are likely to eventually fall under new rules limiting their fees. And credit card interchange is likely to be next on regulators’ agendas, dampening their usefulness to some issuers, the report’s authors contend.
Javelin predicts “it will take a year for the dust to settle” from passage of new debit-interchange rules, but issuers should plan for “the next wave of (payment) industry reforms.”
These various pending and potential rule changes, largely associated with the Dodd-Frank Wall Street Reform and Consumer Protection Act President Obama signed into law July 21, will create “both headaches and opportunities” for payments-industry players, Javelin argues in its 38-page report “Financial Regulatory Reform 2010: Why the Dodd-Frank Act is Only the Starting Point for Reshaping Consumer Protections and Interchange.” Javelin released the report in August.
The biggest looming threat to issuers’ card profits is likely to be debit-interchange rules contained within the financial reform act, Javelin predicts.
The legislation calls for the Federal Reserve Board to set “reasonable and proportional” debit-interchange rates, which would go into effect sometime next year. Observers speculate the new rules will reduce card issuers’ interchange revenue (see story).
It is too soon to know how significantly the new rates will affect debit-interchange revenue, but Javelin estimates between $3.2 billion and $6.4 billion in debit interchange fees could be at risk for affected banks.
A complicating twist is the law’s exemption of institutions with less than $10 billion in assets. That provision, combined with the fact that the law directs the Fed to consider individual issuers’ fraud-prevention costs in shaping new debit interchange rates, could lead to a new multitiered interchange-rate structure, Javelin speculates.
Such a system could be “a nightmare” for the Fed to maintain and for payments-industry participants to follow, Javelin suggests.
The effects of such a multitiered debit-interchange rate structure are many, including the possibility that card networks may decide to require issuers to use the lowest baseline interchange rate for simplicity.
The marketplace friction also likely will give a boost to alternative payment schemes that bypass card-network debit interchange rates, Javelin’s researchers contend.
And clever work-arounds to the new debit-interchange rates may emerge, including smaller banks with less than $10 billion in assets acting as agents for larger banks. Hybrid payment options combining exempt general-purpose reloadable debit cards with traditional debit cards also could surface, Javelin suggests.
But the researchers warn that the new consumer watchdog agency likely will frown on any attempts to flout the new regulations.
Javelin advises card issuers to take advantage of the Fed’s nine-month rule-making process to weigh in with comments to regulators on the complexities of interchange and fraud costs.
The cost of fraud associated with identity theft rose 12.5%, to $54 billion last year from $48 billion in 2008, Javelin estimates. “With identity fraud at an all-time high, it will be imperative for issuers and vendors to convey the extent of fraud solution coverage that is both necessary and appropriate to manage debit fraud effectively,” the firm contends.
New overdraft-protection rules were not part of the Dodd-Frank Act, but fallout could expand if the law’s soon-to-be-established Consumer Financial Protection Bureau determines that certain issuers’ overdraft policies and disclosures are lacking, Javelin warns.
Under the rules, as of Aug. 15 all new and existing checking-account customers must opt in for overdraft protection, which many banks previously offered automatically.
The changes are the result of new Federal Reserve Board rules pertaining to Regulation E of the Electronic Funds Transfer Act (see story).
Javelin asserts that banks have “routinely failed” to equip customers with useful tools to track debit transactions in real time, setting them up to incur costly overdraft charges. The firm suggests issuers immediately begin devising better tools to help customers avoid all types of overdrafts.
Because the new agency may be looking to “score headlines as a watchdog” early on, issuers should ensure their customers “understand their options for coping with debit and ATM transactions ... as well as check and recurring-debit transactions that are not covered” by the Fed’s rules, Javelin advises.
The consumer protection agency also is likely to initiate national financial-literacy campaign, and smart issuers already are stepping up their own efforts to educate consumers about their products and to anticipate questions, Javelin predicts.
Issuers face serious bottom-line and strategic challenges from pending regulations and the effects of a new consumer protection agency that may further restrict business models and operations, Javelin contends.
“This is no time to be complacent,” Javelin warns, urging issuers to quantify the value of electronic payments to regulators and help clarify the interactions of players within the payments system. For issuers, the next year could be “a singular opportunity to influence evenhanded rule-making,” Javelin says.
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