The Federal Reserve Board’s
new interchange rules promise to reshape the US payments landscape.
Charles Davies looks at the wide-ranging impact of the decision,
the winners and the losers, and considers the new restrictions and
opportunities that are opening up as a result.
Go deeper with GlobalData
The Federal Reserve
Board’s new interchange rules usher in changes to debit rewards,
current account products and an era of tighter margins for
issuers.
An amendment in the Dodd-Frank Act
gives the Fed the duty of establishing interchange rates that are
“reasonable and proportional” to the costs that issuers incur on
transactions. Financial institutions with less than $10bn in assets
and prepaid cards are exempt from the provision.
Depending on what the Fed does, the
provision could result in the loss of up to $9.1bn in yearly
revenue for issuers, according to a recent study by CardHub.com, a
website that tracks card products.
Issuers’ debit portfolios already
took a hit from the overdraft rules that took effect in July,
requiring banks to obtain customer consent before charging fees to
cover certain overdrafts.
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By GlobalDataThat, combined with the debit
interchange provisions of the Dodd-Frank Act signed into law in
July, has issuers considering adding account fees, raising minimum
balance requirements and reducing rewards to recoup revenue
losses.
JPMorgan Chase & Co was the
first to disclose its plans when an executive said at a conference
in December 2010 that it would stop issuing debit rewards cards in
February.
Then, US Bancorp announced it will
begin instituting a combination of ending debit card rewards,
instituting debit card annual fees and ending free checking in the
next six months.
Industry representatives objected
loudly to the plan, warning it would set precedents for government
price controls in other industries and describing the rules as
anticompetitive.
A key question is who will
ultimately benefit from the savings? The Federal Reserve’s proposal
to cap interchange fees at 12 cents per transaction would enable
retailers to pass on annual savings of $10bn to $13bn to consumers
– if they ever get to the consumers.
Banks and card networks maintain
that retailers will pocket the savings, leaving consumers with
little more than higher costs for banking and reduced rewards
programmes.
In releasing its proposal in
January, the Fed said it found the cost to banks for processing is
between 7 and 12 cents per transaction. On the average debit card
transaction of $40, for example, the fee is around 24 cents. Wall
Street and the banking industry were expecting that the proposed
cut would call for fee cuts of no more than 60%. The proposal is
close to a 73% cut.
What
alternatives?
The proposal left plenty of room
for the Fed to manoeuvre as it works on a final rule but suggested
the central bank is seeking to cap such fees at closer to the
12-cent mark.
The proposal would also seek to
limit network exclusivity. Under one alternative, a card issuer or
payment card network would have to ensure a debit card transaction
could be carried on at least two unaffiliated networks.
The Fed said that could include one
signature-based network and one PIN network as long as those
networks were not affiliated.
Under another alternative, an
issuer or card network would have to ensure a debit transaction
could be processed on at least two unaffiliated signature-based
networks and two unaffiliated PIN-based networks.
Fed staff noted that banks use
revenue from interchange fees to offer reward programmes and cut
costs on deposit accounts, and noted that they realise that as a
result, banks could trim reward programmes and raise fees on
consumers if the proposal is finalised.
Fed officials indicated they would
listen very carefully to comments on the plan, noting that this is
a new area for the central bank.
“Sometimes when we put out a
proposed rule, we’re pretty convinced that we basically got it
right absent something we didn’t expect getting in,” said Fed
Governor Dan Tarullo.
“The difficulties in implementing
this legislation, the subtleties the staff have had to deploy
trying to come up with a proposal both suggest that we should be
more than perhaps usually open to a variety of comments.”
Fed staff also made it clear the
impact of the proposal would depend largely on how merchants and
banks implemented the new rules. The Fed voted to open the proposal
up to public comment and set a target date of 21 April 2012 by
which a new rule must be hammered out; banks will then have another
three months before it goes into effect on 21 July.
Visa declined to comment on the
proposal. MasterCard issued a press release that said the Fed had
failed to follow Congress’ “statutory directive to consider the
full range of costs incurred by issuers”.
Tien-tsin Huang, an analyst who
covers the payments networks for JPMorgan Securities, said in a
research note that the Fed’s proposal did little to clear up the
potential negative results that Visa and MasterCard face from a
lower interchange environment.
According to Huang, under the
proposal, the Fed said banks could receive a potential safe harbour
for rates of seven cents or below but would be allowed to set them
up to 12 cents to pay for processing costs of the transaction.
Under another option, the Fed would not offer a safe harbour but
would still cap rates at 12 cents.
A rate of 7 to 12 cents per
transaction represents an 80% to 90% cut in the “blended average”
for current signature and PIN rates, Huang said.
Jaret Seiberg, an analyst for the
Washington Research Group, said in a note to clients that “we have
trouble seeing much that is positive here [for banks]”.
“Issuers will lose more on higher
cost purchases and may gain on very small purchases,” Seiberg
said.
Retailers, who had successfully
pushed Congress to adopt a provision in the regulatory reform bill
that required the Fed to set debit card rates that were “reasonable
and proportional” were ecstatic.
“Today’s announcement is a step
forward for the effort to bring relief to merchants and consumers
who for too long have faced excessive fees and unfair rules imposed
by big banks and credit card companies,” said Katherine Lugar,
executive vice-president for public affairs for the Retail Industry
Leaders Association. “Proposed cost reductions will undoubtedly
result in savings for consumers.”
The Fed acknowledged its proposals
still let banks profit from interchange fees, since the financial
reform legislation that led to this round of rule-making only
specifies that fees have to be “reasonable and proportionate”, not
that banks cannot still earn profits.
Supporters of lower fees say the
loss of debit rewards won’t be too painful. The programmes are not
that widespread. Only about 16% of checking accounts have
programmes, and an estimated 30 to 50% of rewards are unused.
As an early mover on debit rewards,
JPMorgan Chase offers a potential blueprint for how US banks will
deal with the reduced interchange. From February the bank will no
longer issue debit rewards cards to new customers, Chase CEO of
retail financial services Charlie Scharf told analysts at the
Bancanalysts Association of Boston Conference.
Scharf told the analysts the
legislation will likely result in “a transfer of value from lower
mass-market consumers to merchants” and will force banks to
increase account fees for most customers in order to compensate for
operational costs that debit interchange fees help to offset.
Chase is developing several new
current account products, it plans to introduce in February 2011
that will require customers to maintain a specific balance and have
multiple accounts in order to avoid fees, Scharf said.
Issuers could also explore explicit
fees for debit cards, maintenance fees on the checking accounts the
cards are linked to and the elimination of debit rewards
programmes, among other options.
New rewards
Options are emerging, including
Bling Nation FanConnect, Clovr and Cardlytics, among others.
Bling Nation is using NFC-enabled
stickers that turn cell phones into mobile wallets and has added
social networking capability. With the help of Merchant360 to
supply targeted rewards and discounts, BlingNation allows customers
to ‘like’ merchants on Facebook at the point-of-sale. Merchants,
meanwhile, can use FanConnect to track buying behaviours.
Cardlytics also offers
merchant-funded rewards to debit card users in the form of
discounts based on their transaction histories.
Cardlytics uses the data feeds of
its bank partners to analyse the debit card activity of online
banking customers, and then matches retail merchants up with
customers based on their purchase behaviours. The merchants then
can direct loyalty offers to customers who spent a preset amount at
their stores.
Clovr, a rewards start-up based in
Massachusetts, offers merchant-funded rewards targeting customers
based on their purchase histories, but by making the card-linked
offers mobile, moves banks and merchants a step closer to the
ultimate in rewards: a location-aware, POS-targeted solution.
Clovr enables card issuers to send
text-based rewards based on the transactions of bank customers that
opt in to the programme. Users click on web-based ads, then link
the offer to the credit or debit card they agreed to use in the
system. Card accounts are credited with discounts after the
purchase, with confirmation coming via text.
Though many issuers will cut debit
rewards across the board, others may offer the programmes to
“premium customers” who maintain high balance levels or use
multiple products. The changes could also usher in a renewed
emphasis on the use of merchant-funded rewards programmes as a way
for banks to continue offering programmes without having to pay
their full cost.
But even with the uncertainties
surrounding future funding of debit rewards programmes, there can
still be a positive business case for many issuers supporting debit
rewards because of the popularity of debit payments and the
product’s central role in customers’ relationships with banks.
To date, US banks have largely
failed to adequately promote their existing debit card rewards
programmes to consumers, according to data from Discover Financial
Services’ 2010 Debit Issuer study.
Pulse recently released additional
findings of its 2010 Debit Issuer based on a survey by
Boston-based consulting firm Oliver Wyman Group conducted among
issuers in February and March last year.
Pulse says 58% of issuers in 2009
still offered some type of rewards programme, up from 53% in 2008.
However, only 17% of survey participants said they are considering
launching a debit rewards programme in 2010, down from 24% last
year.
The data shows that, in programmes
where as many as 75% of bank customers were automatically enrolled
in a debit rewards programme, as few as 9% actually registered on
the rewards programme’s website. Several issuers already have
rewards tied to bill payment and other transactions, according to a
recent report from Corporate Insight.
Broadening debit rewards programmes to cross-promote other bank
products could be a key to success in the future. But the days of
mass-market debit rewards are coming to an end, and free current
account banking could be close on its heels.
