Andrej Eichler, Head of Financial Industry Services at SIX Payment Services, looks at a possible solution to an upcoming problem regarding interchange fees in Europe. Some markets are going to be affected more than others and financial institutions need to prepare. BPO might be the answer to this conundrum
The European cap on debit and credit card interchange fees (0.2% and 0.3% respectively) which takes effect on 9 December 2015, promises to reduce costs for merchants across the continent and potentially benefit consumers through lower prices.
Yet for Europe’s banks, the outcome is not necessarily so positive. In seeking ways to absorb the new cost pressures that this sweeping change will bring, processing efficiency is a logical direction to investigate. Many banks are using legacy platforms that have reached the end of their lifecycle, and – for the smaller players – lack the economies of scale that might help digest the reduced revenue flow.
Pressure continues with compliance issues. PCI DSS, the payment industry’s bible, takes its toll on resources. Even some large and mid-sized European banks are not yet fully PCI compliant – relating to the level of their data security standards – and are already struggling to adapt to the huge demands stemming from the consumer side: to stay in the game when it comes to innovative solutions or new payment devices such as smartphones.
So far, European banks have used interchange fees to fund a lot of their investment costs. With the new caps on fees, these banks will need to look at alternative sources of investment finance.
The solution for some banks may be to contract a payment services provider to do Business Process Outsourcing (BPO).
Under this scenario, banks would retain their customer relationships and would outsource not just the technical processing including card management, authorisation, clearing and settlement etc. but also a choice of their business processes, such as cardholder-setup, contact centre, statement printing, fraud management or even the license sponsoring with the international card schemes, allowing them to leverage security, volume and the expertise of their outsourcing partner and providing a convenient starting point to take on new customers.
We believe this will become an attractive option for many smaller to mid-sized banks, with portfolios of several hundred thousand cards up to a few million, as they reconsider their strategy in the light of the changes to debit and credit card interchange fees. The impact of these changes is likely to be felt in the first months of 2016, as banks adjust to the new cap on charges.
The prospect of global payment service providers (mainly based in the US) offering a similar option is possible, but I doubt whether they will be able to tailor their services to a local European market and the particularities of the bank.
In order to preserve customer loyalty, some banks will also be keen to maintain their tailored version of credit cards for their local customers. Here again, an outsourcing partner can help, offering a ‘white label’ card branded to the local bank, yet with outsourced processing. This scenario will not affect the banks’ cardholders, yet will provide massive efficiency gains for the bank.
Looking at the other side of the ecosystem, I expect that there will be a differentiation between the approaches of different merchants: most smaller merchants tend not to bother with the complex fee structure and appreciate paying an ‘all-in’ charge.
Larger merchants on the other hand are more aware of potential savings and are more prepared to participate in the expected volatility of interchange fees.
Yet whether lower interchange rates will lead to lower prices for consumers remains to be seen. Merchants will certainly be tempted to keep any savings to themselves, whatever national governments or EU regulators would like to happen.
We have already seen that as the differences in interchange rates between debit and credit cards reduce, card acceptance increases. I would expect that these new reduced caps will also boost card acceptance across Europe and will, together with contactless payments and other innovations, further enhance consumer behaviour.
I would like to see more benefits for all parties, from loyalty schemes and other bonuses for card holders, to data analytic services for merchants, helping them to understand their customers, to cross-selling opportunities for card issuers and additional services for card acquirers.
Besides the various benefits that may accrue, there should be the overall advantage of convenience, as both card and mobile payments become faster and more responsive, using near field communication and other technologies. This should also assist in convincing merchants to see card acceptance as an opportunity rather than an inevitable cost factor.
Will card issuers compensate the Interchange Reduction by cutting on cardholder services? There is a danger that as banks find their revenue from interchange fees falling, they will seek to recoup this money by withdrawing reward and cashback schemes, for example. It’s also possible that credit card issuers will raise their interest charges for users who fail to repay balances during the free-funding period and increase upfront banking fees.
The effects of the Interchange reduction change will be particularly felt in certain markets, where card fees are higher. In Germany, for example, average credit card rates are 1.8%; in Poland, debit card charges are 1.6%.
When the European Commission published its Explanatory Memorandum in 2013, setting out why fees should be capped, it used a ‘Merchant Indifference Test’, aiming for a rate at which merchants didn’t care whether they accepted cards or cash. This was to address the widespread misconception that cash is cheaper for merchants than cards.
The new regulations follow an extended campaign by the European Commission to bring down interchange fees stretching back to the 1990s. And it draws on the experience of regulators in the United States, Australia and Switzerland, where there has been stiff resistance from some banks to the changes.
The European Commission believes that lower fees, besides being ‘good for consumers, good for business and good for Europe’, as Competition Commissioner Margrethe Vestager said, will bring both lower prices and greater cost visibility for customers. ‘It reduces a ‘tax’ levied on business by banks in the form of interchange fees, and releases the brakes that have so far held back innovation,’ she said.
According to the Financial Times, the value of card transactions across the European Union in 2011 was 1.9trn ($2trn), and retailers across the continent have paid banks 13bn a year to handle card transactions – 70% of which was for interchange fees.
In the UK alone, the drop in interchange fees is expected to account for savings of £480m ($703m) a year, according to the British Retail Consortium, based on around 10.7 billion credit and debit transactions per year.
So for the banks, the loss of hundreds of millions of euros per year in interchange fees will certainly make a dent in their budget calculations.
Outsourcing their payment processing together with the related business processes could help banks to offset these costs and get ready for new payment methods at the same time.