Background
On May 13, in a surprise move, the Senate passed a financial regulatory reform bill that included an interchange amendment sponsored by Senator Richard Durbin to address debit card swipe fee reform (the “Durbin Amendment”). The decision to advance swipe fee reform came from intense lobbying pressure brought forth by the Merchant Payment Coalition, a group of various retailers and trade associations.
This bill will have a meaningful impact on all constituencies involved in the payments process – from bank issuers to merchants and, ultimately, consumers. Alternative payment platforms are expected to emerge quickly as efficient and cost-effective solutions for banks to offset the likely loss of interchange revenue, for merchants to secure customer loyalty and for consumers to obtain attractive discounts / rewards.
Terms and Definitions
The Durbin Amendment requires the Federal Reserve Board (the “Fed”) to write restrictions on the ability of card networks such as Visa, MasterCard and bank issuers to set debit card interchange fees, or the swipe fees merchants pay to banks for debit card transactions. Under the Durbin Amendment, the Fed would issue rules to ensure that debit swipe fees are reasonable and proportional to the processing costs incurred.
The House and Senate are expected to pass the final legislation before July 4, 2010.
If enacted into law, the Fed would need to establish the regulations within nine months and the new rates would become effective 12 months after the bill is signed. The following offers a summary of the selected key terms and provisions of the Senate-approved Durbin Amendment:
Interchange Transaction Fee
The Durbin Amendment defines “interchange transaction fee” to include debit card fees that are established by a payment card network (e.g., Visa and MasterCard) and that accrue to either the card-issuing bank or to the network itself.
It provides that the Fed cannot regulate network fees (i.e., the fees that Visa and MasterCard charge and that accrue to themselves) except to ensure that the fees are not used to circumvent interchange fee regulation. These changes are a different way of accomplishing the same goal of protecting consumers from loopholes which would allow banks to raise fees to cover any loss in interchange revenue.
Discounting Between Forms of Payment
The Durbin Amendment states that card networks cannot prevent merchants from offering a discount for one form of payment and not another (e.g. decoupled debit versus traditional credit).
It clarifies that the discount must be offered to all prospective buyers and disclosed clearly and conspicuously to the extent required by federal and applicable state law. However, a network would not be permitted to penalize a merchant for a discount that is provided in compliance with federal and state law.
Discounting Between Card Networks
The Durbin Amendment provides that the Fed must issue rules preventing card networks from requiring their debit cards can only be used on one debit card network (thereby ensuring merchants will have the choice of at least two networks upon which to run debit transactions). This provision also provides additional competition to a previously non-competitive part of the market. It allows merchants to choose the debit network with the lowest cost – the opposite of the current system where merchants are forced to use a specific network with fixed prices.
The “New Normal”
If the Financial Reform Bill is passed by the both houses and enacted by President Obama, the payment industry will be propelled into new rules of engagement which will create the “New Normal” for consumers, issuing banks, card networks, processing networks, and merchants.
In our view, the following maps out the “New Normal” for each stakeholder:
Consumers
Consumers may be bearing the true cost associated with the issuance and acceptance of debit cards as a payment settlement method. Consumers playing the bank-issued debit card game may be going past “getting rewards” straight to “bank fee jail”. On a going forward basis, consumers who choose the convenience of using a bank-issued debit card will likely see a reduction in rewards and may be required to pay new bank fees in the form of monthly checking account fees, per-transaction fees, and/or annual debit card fees. Fortunately, consumers today have alternative payment options that provide the benefits of card-based electronic payments without annual or transaction fees. Decoupled debit for example, provides these advantages in addition to consumer rewards and/or discounts.
It remains to be seen if merchants will pass along these newfound savings to its customers. However, similar legislation has been enacted in Australia and the consumer has not enjoyed any material retail discounts. If this is the case in the US, consumers will be significantly harmed in what was advertised to be a consumer protection act.
Card and Processing Networks
The Durbin Amendment gives the card networks (such as Visa and MasterCard) a “get out of regulatory scrutiny free” card. The debit interchange rules specify that the Fed will not directly regulate the network transaction fees Visa and MasterCard charge banks.
The networks will be harmed, though, if the legislation leads to consumers opting out of using debit cards (a major growth driver in recent years for the networks) in favor of alternative payment methods. If transactions growth slows or shrinks, this would lead to lower revenue for the networks. However, this environment also presents opportunities for the networks to be proactive in offering new alternative payment products developed internally or through third party partnerships and create compelling competitive advantages.
Issuing Banks
Banks are bracing for a significant near-term hit to their debit card revenue. It is unclear exactly how the Federal Reserve will adjust debit interchange fees but bankers and analysts agree that the fees are all but certain to come down — and probably by a lot. Industry observers note that fees would be cut anywhere from 25%-75%. According to American Banker, a 50% fee cut decline would likely translate into a $5.6 billion decline in annual interchange revenue for banks that issue Visa and MasterCard debit cards.
Notwithstanding the above, issuing banks may still be the winners if they are able to recoup a portion of this lost interchange revenue (from merchants) with new fees charged to consumers. Many experts anticipate annual checking account fees in addition to possible transaction fees for low-balance accounts.
In addition, banks are in the position to offer its current and prospective customers alternative payment options to create incremental revenue streams. Issuing debit cards to non-customers through an ACH decoupled debit platform is just one example of how banks can leverage the innovative alternatives out in the market today to combat shrinking revenue from traditional products.
Merchants
Merchants, through their lobbying efforts, have certainly won the interchange battle but have they won the war?
Consumers, faced with less available credit, annual debit card fees or per-transaction fees for debit cards may well move their payment preference to cash, checks, or some new form of alternative payment like decoupled debit that does not require additional consumer fees.
Traditional paper-based payment forms have proved to be costly and inefficient. Cash creates security issues and does not facilitate easy auditing. Checks are slow to process and increase overall transaction costs (handling and check guarantee fees). In addition, it is likely that banks will increase merchants’ fees for cash deposits.
Merchants have the option of accepting more payment alternatives than ever before. The most effective alternatives must provide an electronic-based payment system which will ultimately be cheaper and more convenient for consumers and merchants.
Payment Alternatives
The new crop of alternative payment providers are developing solutions like decoupled debit and prepaid, to solve some of these issues. These companies are well-positioned to play a key role with issuing banks, card and processing networks, and merchants that are adapting to the effects of the financial regulatory reform bill and the new rules of engagement that will reface the “New Normal” in the payment industry.
Products like decoupled debit do not tax consumers with any per-transaction or periodic fee. The rewards are not interchange-reliant but instead are individually funded by merchants for consumers shopping at their store. The rewards will continue to be robust because decoupled debit drives sales directly to the merchants who fund the rewards.
In addition, alternative payments that help banks compete more effectively will also continue to see momentum and attract interest. Decoupled debit products would provide banks themselves with an entirely new revenue stream (to help offset the reduction in debit interchange). It enables banks to issue additional debit cards to consumers who are deposit customers of other banks through the ACH settlement system. The issuing bank would capture additional interchange revenue through these incremental card transactions.
