Unstoppable is the only word for the performance of debit cards in Europe.
  By the end of 2002, the latest year for which there are complete figures, there were over 14 billion debit card payments across the 28 countries of the Single Euro Payments Area, or SEPA. Despite the maturity of many markets, the compounded annual growth rate was more than 15% for the period 1999-2002 (chart, page 42).
  "Debit is the fastest-growing non-cash payment instrument," says Ken Howes, a director of San Francisco-based Edgar, Dunn & Co., an international payments consultancy. "Debit is also growing faster than ATM withdrawals in most countries."
  But on a best-case scenario, 'we ain't see nuthin yet.' Assuming that banks, merchants and regulators can agree on the ground rules and infrastructure, debit transactions could rise even more spectacularly over the next five to 10 years. In several countries, average annual transactions per card are close to or above 100. Impressive though these figures are, they can go a lot higher, says Marc Temmerman, executive vice president of external relations at Visa International EU, London.
  "We should be thinking in terms that 100 times a year is a failure-four or five years out, the figure should be 200 times," he says. That would lift debit transactions in the SEPA region to 75 billion per year.
  The rates of growth, as might be expected, are fastest in the central and eastern European (CEE) countries that joined the European Union in May, with compounded annualized growth rates during 1999-2002 generally in the 80% to 90% range. These countries have only been operating modern retail banking systems since 1992-3, and in the early years, cardholder usage was almost entirely at automated teller machines. However, use of debit cards for payments is beginning to take off.
  In Western Europe, debit payments have been growing at 30% to 40% in markets like Ireland, Spain and Sweden, which were relatively late in adopting debit. Among the early adopters-Belgium, Denmark, France and the Netherlands, which launched national debit card programs in the mid-1980s-debit growth rates are in the 9% to 15% range.
  Though more pedestrian, these rates are still well ahead of all the macroeconomic growth measures, indicating that debit payments are capturing an increasing slice of personal consumption expenditure, or PCE. By 2002, the most recent year for which full data are available for most countries, debit cards made up nearly 12% of total PCE in the 15 pre-expansion European Union countries (chart, page 43).
  Denmark, the Netherlands and France are at the top of this league. The average is dragged down by sub-par use of payment cards, including debit, in the traditionally cash-focused markets of Germany, Italy and Spain.
  Not surprisingly, the economic importance of debit cards, driven by their popularity with consumers and merchants, has taken on increasing significance not just with national governments but also with European Central Bank and European Commission (EC) officials responsible for supervising the SEPA concept. (The EC is the administrative arm of the European Union.)
  If debit cards are to continue to thrive, they will have to comply with an increasingly demanding set of requirements from Europe's regulators. Over the next three or four years, the implementation of SEPA will shape debit cards, and therefore the entire retail payments landscape in Europe, probably for a generation.
  The official aim is to make retail payments within SEPA "as efficient as the most efficient national payments today," says Jean-Michel Godeffroy, European Central Bank director general, payment systems. "Cards are the best instrument for SEPA, the most favored."
  To achieve SEPA's goal of seamless cross-border payments, "national standards, business practices, infrastructure and payment instruments will have to become pan-European," says Godeffroy. "Any card (must be usable) at any terminal to pay under the same conditions as they do at home."
  This requirement, enshrined in EU regulation 2560/01, has mainly affected cross-border ATM transactions to date and is now set to impact point-of-sale transactions as SEPA redefines Europe's payment borders.
  In the CEE countries, banks have generally implemented so-called four-party debit schemes, with either MasterCard International's Maestro or Visa's Electron branding and a multilateral interchange fee (MIF) as the default if banks do not set up bilateral arrangements. (Under four-party programs, a transaction involves the regular Visa/MasterCard interchange system with a cardholder, issuer, merchant and merchant acquirer. In contrast, "three-party scheme" is a term Europeans use for programs in which the issuer and acquirer, such as American Express or JCB, are the same and no interchange is paid. In Germany, three-party debit schemes involve issuers, cardholders and merchants; there is no acquirer.) Nearly all CEE terminals accept Maestro and Electron, as well as Visa and MasterCard, and there is little domestic-only branding.
  But the "old Europe" is a mix of three-party and four-party debit programs, some of the former with zero or negligible interchange, and of debit card types that include domestic-only, domestic with international branding and internationally branded-only (chart, page 43).
  In Denmark, all three types co-exist: Dankort, Dankort with Visa branding and Maestro/Electron-only branding. In the United Kingdom, the majority of debit cards are Visa-branded, while Switch domestic cards are migrating to Maestro. In France, nearly all "CB" cards have MasterCard or Visa branding, with just a handful of "CB"-only cards still outstanding.
  If it was just a question of adding cross-border functionality to domestic-only cards, this could be achieved by the simple and commonplace operation of upgrading the remaining domestic-only cards with international branding. The harder part, however, is complying with the regulatory requirement for cards to be accepted "at any terminal," which signals the end of the road for domestic schemes and opens up the region to pan-European acquiring of all card types, including domestic debit programs within just one country.
  "There was a thought that national systems could continue, if the market wishes," says Godeffroy. "But the reality, as with large (value) payments, is that there will be full integration."
  Many of Europe's debit pioneers, including Austria, Belgium, Denmark, the Netherlands and Switzerland, launched debit schemes in the 1980s as a collective effort. Banks banded together to create interbank companies like PBS in Denmark or Banksys in Belgium to switch ATM and POS transactions to issuing banks and to serve as the sole acquirer of POS transactions.
  The first debit systems were in eurocheque (a European checking program) countries such as Austria, Belgium and the Netherlands and were created on a shared basis, with domestic standards and a single processor and acquirer, according to Ann Camarillo, chief debit officer, MasterCard International.
  "The next generation of countries learned from that-later launches are with international branding, multiple acquirers and multiple processors," she says. "The real issue is moving Western Europe to this model, and the biggest amount of change will be where there's only one acquirer in a market."
  But some of early-adopting debit countries now operate the region's most efficient programs, judged by measures like annual debit card payments per card. Among elements of the national government, the interbank network and many of the banks, there is often resistance to changing a successful formula to comply with the SEPA ideal, particularly as most transactions still take place within national borders. Debit participants will incur costs to open up the entire POS network to accept cards from foreign visitors without necessarily being rewarded with substantial compensating revenues.
  Denmark is the most obvious case, with the popular Dankort debit scheme dominating the market and appearing to comply fully with European Central Bank and European Commission aspirations to replicate the most efficient national payment systems at the SEPA level.
  "Nearly 95% of Danish adults possess a Dankort card and acceptance is 98% of merchants," says Jorgen Bo Andersen, senior vice president of global cards at Danske Bank. However, though 115,000 merchants in Denmark accept Dankort, only 22,000 accept Visa and MasterCard brands, he says.
  To meet the "any card, any terminal" requirement, these merchants will somehow have to be persuaded to accept international cards-and at what level of interchange is the crucial issue. In the interim, "a parallel system" has developed, Camarillo says, with the Danske and Nordea banks respectively issuing Maestro and Electron.
  Denmark may yet become a test case for the powers of the EC versus national authorities in the matter of payments.
  "The EC validated the four-party model (in its 2002 ruling forcing down Visa's European Union interchange rates over five years) and domestic governments will be hard-pressed to challenge it," Camarillo says. But there are signs, disturbing for the banks, that under pressure from merchants, the EC is having second thoughts about its Visa ruling.
  While the final decision will probably support the four-party system, this will be widely resisted and will in effect have to be imposed by the EC on countries with three-party systems. The quid pro quo is likely to be a low, unified, SEPA interchange rate for chip and PIN-based debit transactions in place of the current variations (chart, this page).
  In the interim, European card payments are in a state of flux:
  * Regulators will be seeking the most efficient and secure (not necessarily the cheapest) debit-based payment system, complying fully with the SEPA concept and effectively combating fraud;
  * Merchants will insist on transparent fees, unbundling of the services provided in the multilateral interchange fee and greater competition between service providers;
  * Banks will have to try to reposition debit as a service priced acceptably to non-bank stakeholders, but also giving them a return on their investments in Europay/MasterCard/Visa "chip and PIN" smart card investments across the region. Under chip and PIN, European card programs are being converted to chip cards that also will require the cardholder to enter a personal identification number at the point of sale.
  Meanwhile, European banks, together with MasterCard and Visa, are struggling to reshape their debit operations in "old Europe" in a favorable manner. The difficulty will be to change the perception of consumers and merchants, reinforced by regulators, of debit as a public service.
  "Consumers expect free access to their current-account funds, while merchants expect commodity pricing for debit," says consultant Howes. "Merchants argue debit card transactions should be regarded as a utility cash substitute, and priced accordingly-they believe cash is cheaper (for them to handle) than debit."
  Xavier Durieux, secretary general of EuroCommerce, the retailer community's Brussels-based lobbying organization, says, "Our studies in the U.K. tend to prove cards are more expensive than cash handling," a surprisingly tentative statement. The U.K. analysis, however, was undertaken by the British Retail Consortium in the late 1990s and probably needs updating.
  An adjustment of the pricing of cash, debit and checks is a promising way forward for the banks as they grapple with the multiple issues posed by SEPA. Checks are used mainly in France and the United Kingdom and have little role to play, so cash is key. The factual basis will need to be unassailable and the repricing will have to be transparent and command support from regulators, merchants and consumers.
  An analysis by Edgar, Dunn shows that "cash in circulation continues to increase and remains a significant area of cost," says Howes. "The cost of cash to commercial banks in the eurozone is ?32 billion (annually) and likely to grow."
  Costs vs. Revenues
  Among the reasons are that central banks are closing branches and reducing cash handling, pricing regulation remains and transport and security costs are rising. In addition, cash in circulation is tending to increase, particularly in the eurozone countries-those that now use the euro currency.
  "Across payment types, banks have not aligned revenue with cost," Howes says. Pricing of cash to merchants is confused by several factors:
  * Bank charges to merchants for cash-handling services are regulated in some countries;
  * Cash costs are bundled in with more profitable products;
  * Merchants fail to calculate the true internal cost of cash;
  * Merchants compare the pricing of card transactions with the purportedly free provision of cash.
  "If merchants were charged for payments on the basis of costs incurred by the banks, there would be a migration to more efficient payment types," says Howes. "The optimal point above which debit is cheapest for merchants falls to $12. Pricing appropriately can accelerate substitution benefits both for banks and merchants."
  The reason banks often manage cash for merchants for free "usually comes from the corporate relationship, not from the acquiring side of the bank," says MasterCard's Camarillo. "They should stop cross-subsidizing-it may have worked in the past, but the components have all changed now."
  If banks understood their costs better, and "the 'sweet spot' goes down to $12, it's better to accept debit," she says. Average debit transaction values are much higher than this in every country, ranging from ?70 ($85.30) in Germany to ?45 ($54.85) in Denmark and Norway.
  Accurate figures for the cost of competing means of payment are needed urgently, Camarillo adds.
  "Regulatory intervention goes in favor of the merchants because the banks haven't got their numbers out there," she says. "We've been working with them for several years to get the data and when the merchants understand it, they love it-especially Switch in the U.K."
  Leveraging chip and PIN investments will also help to reinforce relationships with the retailers. "Visa has been trying to get closer to them and understand them better," says Temmerman, adding that what leading retailers such as Carrefour, Tesco and Metro "want is to take costs out of the system."
  Developments like migration to self-checkout in stores are on the agenda for most big supermarket groups and chip and PIN-based debit will be a key enabler, he adds. "We have an opportunity to help their objectives happen and it will be good for both of us."
  In the medium-term, the challenge for card issuers is to drive up debit volumes in the 12 or so countries where transactions are below the SEPA average. Over the longer haul, lifting annual debit transactions to 200 per card would position debit cards to challenge the dominance of cash across the region.
  If this, or something like it, can be achieved, debit issuers will be able to claim to benefit all their stakeholders-consumers, merchants and regulators-as well as themselves.

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