This story appears in the February 2009 issue of Cards&Payments.

Merchants and debit card issuers have waged their battle at the point of sale for at least a decade, but neither side is giving in, at least not yet. Merchants want debit card users to enter PINs to create lower-cost transactions, but card issuers and the major card networks continue to use their marketing muscle to drive debit transactions requiring signatures.

And analysts say any reports of signature-debit's demise are premature, though issuers' PIN-debit interchange revenue is starting to grow. Merchant banks pay issuers interchange and pass the expense on to their merchant clients as part of the discount rate.

More debit card rewards programs require customers to use their signatures to qualify, and it appears to be having an effect. PIN-debit's growth rate seemed to be on track to enable PIN debit to eventually surpass signature debit purchases a few years ago, but signature-debit's growth rate now will outpace PIN debit's over the next few years, speculates Tim Sloane, group director at U.S.-based Mercator Advisory Group.

Over the past few years, the EFT and bankcard networks have stopped disclosing their PIN- and signature-debit transaction activity, making it virtually impossible to know specifically where the debit card market is headed.

However, the tug-of-war between the two types of debit may become more significant as the recession prompts more consumers to use debit cards instead of credit cards for everyday transactions. Debit card payments overall officially surpassed credit card payments in 2006, according to ATM&Debit News, a Cards&Payments sister publication.

"The debit pie is growing," says Bruce Cundiff, research director with U.S.-based Javelin Strategy & Research.

The economic downturn is driving consumers to use debit even more heavily to help control their spending, Cundiff says. "Whether or not (debit transactions' growth) is coming at the expense of credit (card transactions), issuers are intent on capturing all the revenue they can from signature debit," he says.

One interesting twist in the struggle between merchants and issuers over their debit preferences could be a movement toward more-closely matched interchange rates. PIN-debit rates, which traditionally have been lower than signature-debit rates, are creeping upward (see story).

Significant differences exist in the mechanics of the two debit types. Signature-debit transactions typically occur offline in that issuers or third-party processors immediately authorize them but are settled a day or two later. Bankcard networks switch the transactions through the same paths as credit card transactions, though they tap checking accounts instead of lines of credit.

Electronic funds transfer networks, such as Metavante Corp.'s NYCE, Discover Financial Services' Pulse and First Data Corp.'s Star, switch PIN-debit transactions, which issuers authorize and settle almost immediately. Such transactions also are more secure because they require cardholders to enter personal identification numbers to authenticate themselves at the point of sale.

NYCE, Pulse and Star are among the leading EFT networks locked in fierce competition with the bankcard networks in the debit arena, primarily in switching PIN-debit transactions.

Rate Variances
Visa Inc. switches the largest number of signature-debit transactions, but it also handles millions of PIN-debit transactions through its Interlink point-of-sale debit network. MasterCard Worldwide also switches signature-debit transactions through the MasterCard payments network, and it routes PIN-debit purchases through its Maestro debit network.

Merchant acquirers generally pay about 50 cents for a typical PIN-debit transaction, while a signature-debit transaction yields interchange fees ranging between 1.2% to 1.5% of the sale, plus about 10 cents. PIN-debit networks typically cap the fees at about 65 cents, while signature debit has no cap. Credit card interchange rates can range between 1.8% and 2.2% of the sale.

 For some lower-cost purchases in certain retail categories, a signature-debit transaction could cost less for a merchant to accept, according to Adil Moussa, an analyst with Aite Group. On a $40 general-category retail transaction, for example, a PIN-debit transaction could cost a merchant between 50 cents and 60 cents, whereas a signature-debit transaction based on a 1.2% interchange fee could cost about 58 cents. On a $100 transaction at the same retailer, the PIN-debit fee may max out at 65 cents, while the signature-debit fee would be about $1.30.

NYCE, Pulse and Star declined to comment on trends in PIN- and signature-debit transactions, pricing or competition with the bankcard networks. However, sources tells Cards&Payments that the networks' published rates often do not match the rates that eventually apply because of negotiation.

"I'm not surprised the EFT networks are playing things very close to the vest," Cundiff says. "The EFT networks have to fight for financial institutions' debit business, primarily on the PIN-debit side, while Visa and MasterCard have become very aggressive in pushing debit overall. The fact that Visa and MasterCard offer both PIN and signature debit puts the EFT networks at a distinct disadvantage."

Mercator's Sloane speculates that, despite a slight increase recently in PIN-debit rates, EFT networks will work to maintain PIN-debit rates "sufficiently below" signature-debit rates to keep merchants interested in pushing PIN-debit at the point of sale.

In the early years, the lack of payment terminals equipped with PIN pads thwarted PIN debit's marketplace growth. Moreover, through the 1990s financial institutions often charged debit cardholders using PINs at the point of sale fees similar to those assessed at ATMs. But those charges largely have disappeared, and analysts estimate that more than half of all payment terminals now are equipped with PIN pads.

Some 65% of issuers' debit transactions are signature-based, and 35% are PIN-based, according to the 2008 Debit Issuer Survey U.S.-based Oliver Wyman conducted on behalf of Discover's Pulse network. Between 2003 and 2006, the number of PIN-debit purchases increased an average of 17.5% annually compared with 15.8% annually for signature-debit transactions, according to the Federal Reserve.

Gap Widening
Signature-debit's share of the total continues to grow. Oliver Wyman's debit survey of 62 financial institutions encompassing 74.2 million debit cards in February 2008 showed that issuers forecast signature-debit transactions to increase 16.2% last year, while they expected PIN-debit transactions to grow by 17.7%.

Determining the fees merchants pay for signature- and PIN-debit transactions is difficult because they may vary widely depending on the size and type of the merchant and the amount of the sale, says Jennifer Roth, a senior analyst with TowerGroup, an independent research firm owned by MasterCard Worldwide's MasterCard Advisors unit.

"Changing dynamics in the marketplace make it difficult to compare and analyze merchants' debit costs," she says. "Certain retail categories such as supermarkets have unique debit-fee structures, and it gets very complicated to compare them."

PIN-debit transactions also have lower fraud rates because of the required PIN, while signatures are relatively easy to forge. Between 2005 and 2007, the average fraud cost on PIN-debit transactions was 1.09 cents per $100 of card spend compared with 5.4 cents per $100 of card spend on signature-debit transactions, according to Oliver Wyman's survey.

Fraud Expectations
Some 49% of issuers Wyman surveyed last year said they expected signature-debit fraud rates to increase, 37% said they expected to see higher fraud rates among PIN-debit transactions, and 44% said they expected no change in debit-fraud rates.

Increasingly, merchants have the upper hand at the point of sale in determining whether consumers use signatures or PINs. That is because more payment terminals automatically prompt consumers to enter their PINs on all debit transactions.

Customers can override a merchant's prompt for a PIN, usually by pressing the "credit" button on the terminal to effect a signature-debit transaction. Many consumers do so to secure debit rewards, which many issuers provide only when cardholders sign for their debit transactions.

Wells Fargo & Co., for example, last December unveiled an enhanced debit card rewards program that gives customers 0.25% of the sale back in cash on all signature-debit purchases. Citigroup Inc.'s Citibank last September offered its customers the chance to win 1 million of its ThankYou Network rewards points in a sweepstakes each time they made a signature-debit purchase. And many debit card rewards programs MasterCard and Visa support for issuers require signatures to qualify.

"Signature debit is essential to many issuer-funded debit rewards programs," says Tyson Nargassans, president and CEO of U.S.-based Saylent Technologies, which consults with financial institutions on rewards programs.

But more issuers will move to less-costly merchant-funded rewards programs in the future, which could dampen signature-debit's long-term growth momentum, he speculates.

Although chip-and-PIN technology is spreading in most international markets, Ed Kountz, an analyst with Jupiter Research, says U.S. card issuers are unlikely to migrate away from magnetic stripe cards within the next few years, a fact which favors ongoing use of signature debit.

"Issuers here have a huge investment in magnetic stripe card technology, and it's not going away anytime soon," he says.

Signature debit is likely to maintain its hold in the U.S. for years to come. The debit conflict between merchants' and issuers at the point of sale also will rage on.  CP

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