In a classic comedy sketch, Monty Python’s John Cleese walks into a pet store and demands a refund after realizing that the parrot he bought just half an hour earlier is dead—or, as Cleese puts it, the parrot "has torn down the curtains and joined the choir invisible." But the shopkeeper, played by Michael Palin, assures his customer that the bird hasn’t expired—it’s merely "pinin’ for the fjords.’" Cleese may very well have been presenting Palin with a decoupled debit card, a payment vehicle that caused quite a bit of squawking two years ago, but which is now, like Palin’s parrot, "just restin’."

In May 2007, McLean, Virginia-based Capital One Financial Corp. shook up payments-industry pundits and a lot of bankers by introducing a decoupled debit card co-branded with regional grocery chains and bearing the MasterCard logo. The idea, as with all decoupled debit cards, was to provide a card enabling consumers to withdraw funds from a checking account sitting in a bank that didn’t issue the card.

"Alarm bells went off in the banking community," exclaimed trade journal Bank Systems & Technology shortly after Capital One announced the cards. Analysts labeled the cards a "threat" to banks’ checking accounts. U.S. Banker warned of "disruptive" consequences.

Observers surmised that Capital One and other financial institutions might use "open loop" decoupled debit cards (in which a third-party like Capital One assumes risk management) to form relationships with consumers, and then offer credit cards and loans to those new customers. Thus, some feared, rogue financial players would steal depositors, hijack borrowers, and destabilize the banking scene. To make matters worse, retailers might begin acting more like pirates than merchants, using "closed-loop" decoupled debit cards as an updated version of their nearly moribund store cards. That way, store chains could sidestep credit card interchange fees and avoid competing with banks for debit-card business.

Today, calm prevails. Capital One has quit the decoupled debit card business, at least for now. The credit card behemoth completed its 12-month test of the cards and is keeping mum about what it learned. Meanwhile, during infrequent conversations about decoupled debit, industry insiders tend to mention closed-loop cards only as an afterthought.

But signs of life are appearing in decoupled debit—if not in the Monty Pythonparrot—with recent announcements of new closed-loop decoupled debit cards. And proponents of open-loop decoupled debit seem far from ready to admit defeat.

Rewards rule
Observers agree upon at least one point. Open-loop or closed, all decoupled credit cards have something in common—they provide opportunity for retailers to fund loyalty rewards with the money they save by avoiding credit card fees. Along with other solutions gaining traction, such as merchant-funded rewards, decoupled debit rewards have the potential to outshine reward programs paid for by profits from debit cards coupled to checking accounts, which carry smaller interchange rates than credit cards.

"From a merchant perspective, decoupled debit is about loyalty," says Patricia Hewitt, Director of Debit Advisory Services for Maynard, Massachusetts-based Mercator Advisory Group. "It’s about creating fuller, richer rewards programs to increase sales."

With open-loop cards, a branded network, such as MasterCard, performs and settles transactions online between a merchant and an intermediary, such as Capital One. Funds are then deducted from the consumer’s checking account and paid to the intermediary using the offline automated clearing house (ACH) network. Any merchant that accepts the card brand would accept the decoupled debit card. Closed-loop decoupled debit cards, meanwhile, are issued by merchants instead of financial institutions, and usually work only at one store chain or a network of merchants. Closed-loop cards aren’t required to include an association logo, although they sometimes include one, and rely on the ACH backbone for transaction processing.

Open and closed both offer advantages and pitfalls for consumers, merchants, card brands, banks and other financial institutions. Let’s look first at closed loop, because that’s where the action has been in recent months.

The Parrot Has a PULSE:

The 2009 Debit Issuer Study from PULSE—an electronic funds transfer network based in Houston, Texas—surveyed 73 financial institutions in conjunction with Oliver Wyman Group. One nugget in the findings shows that the parrot may not be flying quite so low under the radar:

It’s alive
Regional closed-loop decoupled debit cards, many of them good only at a single supermarket chain, have existed quietly for well over a decade, but the first national version became available in January from Houston-based Shell Oil Co. The Shell Saver Card, which carries no application or annual fees, offered consumers a discount of 5 cents per gallon of fuel at all 15,000 of the nation’s Shell stations until June 1, 2009. After that, the discount shrank to 2 cents per gallon.

Shell credit cardholders receive richer rewards of 5 percent cash back, but Shell says the Shell Saver decoupled debit cards should appeal to the 50 percent of all customers who don’t qualify at a given moment for a new credit card, or those who simply prefer debit over credit.

Shell launched the card with a flat merchant service fee of 28 cents per transaction but stopped charging operators a fee as of April 1, 2009. Third-party consumer credit card fees average 2 percent and debit transaction fees average 1 percent, a Shell spokesperson says. The approval rate for Shell Saver Cardsapproaches 98 percent, compared with 30-35 percent credit card approval rates.

Greenwood Village, Colorado-based First Data Corp. routes Shell Saver Cardtransactions through the Shell network and uses First Data’s TeleCheck check-verification services to process the transactions. Station operators need not install any special equipment to participate, says Tim Horton, First Data Vice President of Product Management.

The Shell Saver Card could get some stiff competition right away if Joe Randazza, President and CEO of the Coconut Creek, Florida-based National Payment Card Association (NPCA), realizes his vision. Randazza plans for nothing less than a nationwide empire of decoupled debit card acceptance at fuel and convenience retailers.

Until recently, NPCA’s network had been processing decoupled debit transactions for just 15 small petroleum chains. To participate, retailers had to spend about $1,000 per station just for equipment, which limited the program’s appeal. In April, however, NPCA signed a deal to process transactions using the connectivity of Nashville, Tennessee-based Fleet One LLC. The deal eliminates the need for a costly extra box on the checkout counter. Fleet One, which offers fuel cards and services mostly to government and commercial customers, has a network of 50,000 stations, or about one-third of the nation’s total, according to Michael Thompson, Fleet One Senior Vice President of Sales and Marketing.

NPCA and Fleet One share the profits on a 1.9 cent per gallon fee they charge the gas retailers, seriously undercutting the 5 cents or so per gallon the credit card brands were charging at press time, Randazza says. The petroleum sellers can use part of the roughly 3-cent difference to fund bigger rewards to attract customers to the cards.

NPCA also provides services to the three primary constituents of the decoupled debit cards: Fuel, supermarkets and drug chains. The company helps fuel purveyors, many of them relatively small regional companies, market store-branded cards with point-of-purchase displays, sends email alerts to remind consumers how much they have saved by using their decoupled debit cards, and provides detailed tracking information on their customers’ card purchases for use in targeted marketing campaigns. Moreover, Randazza claims that the retailers gain customer satisfaction and market power by offering their own cards.

"There’s no better way for you to control your own destiny than to have your own program and bypass the competition," says Randazza. Gasoline retailers might achieve their goal of getting a say in setting interchange fees if they can siphon off from 3 percent to 8 percent of the transactions, he says.

Analysts say that it’s no accident that the ambitious new national closed-loop efforts involve gasoline retailing, where customers make frequent small-ticket purchases. Likewise, grocery chains offer regional closed-loop decoupled debit cards because those purchasing patterns hold true there, as well. The flat fees charged for decoupled debit transactions make less sense, meanwhile, for big-ticket purchases than the percentage-based fees of credit cards. The infrequency of big expenditures also defeats many loyalty schemes on closed-loop initiatives.

"These types of products make sense in a retail environment where there are persistent amounts of recurring transactions and where consumers see any reduction of cost as of great value," says Mercator’s Patricia Hewitt. "Gasoline is a great example of that."

The power of the network
While closed-loop decoupled debit cards are springing to life, open-loop remains in "resting" mode. But payments industry executives with a stake in the open-loop parrot insist that a great awakening will occur.

The proponents of open loop include Scott Grimes and Lynne Laube, two executives often credited with developing the Capital One decoupled debit card. The pair left Capital One to form their own company, Atlanta, Georgia-based Cardlytics Inc., which helps merchants base rewards offers on transaction data gathered by banks. Grimes serves as Cardlytics CEO and Laube as Chief Operating Officer. Grimes says that the current stage of the open-loop decoupled debit card industry mirrors the early stages of the credit card industry.

"The first decade of the credit card industry had its fits and starts as people tried to figure out the business model," says Grimes. "Decoupled debit is very similar."

Laube agrees. "It’s like any cutting-edge product. This product is going to grow and evolve over time. I would not say decoupled is dead by any stretch of the imagination."

Because of the slim margins in the debit card business, however, finding a way to fund rewards rich enough to attract customers to open-loop debit remains a challenge, Laube says. "That’s one of the big things anyone struggles with when they think about decoupled debit."

The reasons behind Capital One’s unexpected decision not to go national with decoupled debit aren’t public, but likely the numbers just weren’t there. As Marianne Berry, Managing Associate in the Berlin office of Westbury, New York-based Auriemma Consulting Group, says: "If the test had been wildly successful, they’d be rolling it out."

Still, open-loop decoupled debit has its merits. Berry says that some financial institutions might want to keep open-loop alive as a way of defeating geography, noting that, while consumers tend to open checking accounts at nearby institutions, decoupled debit networks can operate nationally. Open-loop decoupled debit also makes sense because consumers sometimes view credit cards as a difficult-to-control vice that can lead to overspending.

"The U.S. consumer is increasingly moving to debit, and the recession probably is going to accelerate that trend" says Gwenn Bezard, Director of Research for the Boston-based Aite Group LLC.

Unlike closed-loop, which works at only one or just a few stores, open-loop offers consumers the advantage of using the card at any store that honors the card brand, notes Mike Grossman, CEO of San Mateo, California-based Tempo Payments Inc., which is concentrating these days on open loop. Tempo lists Prospect Heights, Illinois-based HSBC Bank USA as one of its investors, and the two cooperate strategically, Grossman says.

Could the future hold a two-tiered card that offers bigger rewards for debit purchases at a cobranded retailer and still works at most stores? "I don’t know if anyone’s done it, but it’s exactly what’s being pursued right now," Grossman says, calling two-tiered cards "the model that you will see emerging."

Combining richer rewards with the flexibility of a card almost any merchant will accept could someday prove that decoupled debit—unlike that Python parrot—has merely been resting.