The political intrigue in Washington
may be far from over as the interchange war rages on but
it’s not too early to envision what the US payments landscape might
start to look like, writes Charles Davis
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The Federal
Reserve Board might very well be feeling the political heat as it
delayed release of its final debit-interchange rules, even as
legislative efforts to introduce a two-year delay in implementing
the new regulations have opened a new front in the interchange
wars. Also on the Fed’s radar is TCF Bank’s lawsuit seeking to
block implementation of the Durbin amendment as an unconstitutional
infringement of its right to recoup the costs of providing debit
services.
Still, the consensus holds that the Fed is
taking its time to try to find a workable solution – one sure to
infuriate the larger debit issuers in the US but one sturdy enough
to withstand the inevitable wave of litigation to come.
Under the Fed’s proposal announced in
December, interchange rates for debit cards would be capped at 12
cents per transaction for issuers with more than $10bn in assets –
a huge drop from the current average of 44 cents.
Retailers welcome
the Feds proposed cap, saying debit fees have forced them to raise
prices. Consumer advocates say these higher prices are being borne
by all customers, whether they pay with plastic or not. And banks
say a cut in fees means they may have to make up the revenue by
taking away free checking accounts and other services.
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By GlobalDataBanks, retailers and consumer advocates have
all played outsized roles in the regulatory saga, but none plays a
role in setting the actual processing fees. That’s the province of
the card associations, whose interchange rules are the subject of
yet another massive lawsuit by dozens of the nation’s largest
retailers.
Retailers and consumer groups are infuriated
by the fees that banks charge retailers for debit transactions,
which have risen to that 44 cent average from an average of 7 cents
in the past decade, according to Federal Reserve Bank
statistics.
Interchange might very well be viewed as a
victim of the success of debit cards. According to the Fed, debit
card purchases now represent about half of all consumer purchases
in the US, while paper cheques account for 30%. Shoppers used debit
cards nearly 38bn times in 2009, up from about 15bn times in 2003.
With that volume of the market, retailers say they have no choice
but to accept debit cards.
Since banks earn money from each card swipe,
increasing card use has meant increasing costs for merchants. But
it’s not just the incidence of card use that has gone up. The cost
to merchants for each card swipe has grown, too.
Exactly how much it costs banks and the card
companies to process a debit card purchase varies based on whether
a consumer uses a PIN-based debit card or a signature-based debit
card. Since 2000, many PIN debit cards have adopted a fee that is a
percentage of the value of the transaction.
Are schemes to blame?
Critics of interchange blame the competition
between MasterCard and Visa for driving up fees over the years, in
part because their business interests are more aligned with banks
than with retailers, while banks and the card associations say the
increases reflect the true cost of mitigating risk and switching
transactions.
The debit processing fee helps pay for the
electronic network that authorises, clears and settles each
purchase. It also helps defray the costs of fraud, fraud
prevention, data security, customer assistance and disputes, and
producing debit cards, according to banks.
The associations have spent most of the past
decade fighting off a never-ending legal onslaught. The Justice
Department and mega-merchants like Wal-Mart won concessions on
grounds that Visa and MasterCard’s behaviour has been
anti-competitive. Most recently, the associations agreed in an
October 2010 settlement with the government to stop prohibiting
merchants from offering discounts to customers who use a card that
carries lower interchange fees.
The associations have consistently defended
themselves by arguing that consumers have a multitude of payment
options, from cash, credit, and cheques to a host of emerging
alternative payment methods. The central legal fight – the lawsuit
filed by a consortium of the nation’s largest retailers – has been
mired in pre-trial motions since 2005, but has still cost all
parties dearly in time and money.
As for the TCF lawsuit, observers said that it
faces long odds and appears to be working against the best
arguments in favor of those seeking a delay in implementation of
the Fed rules – an ambit widely seen as the best bet, politically
speaking.
Anti-competitive
landscape
TCF argues that the amendment’s exemption in
the law for banks with less than $10bn in capital means creates an
unlawful advantage for smaller banks, which will use their higher
interchange revenue to offer higher rewards and poach customers
from the big banks.
That position seems to undercut the strongest
argument for a delay, namely that competition will drive debit
interchange fees down to the nonexempt level. Let market forces
work, argue proponents of a delay, and fees will drop to levels
that will remove any need for price controls.
Overwhelmed by more than 11,000 public comment
letters and one of the most impressive lobbying battles in the
nation’s history, the Fed missed its April 21 deadline to issue a
final rule on the interchange fee cap. But the Fed recently said it
was committed to completing the rulemaking before July 21. Because
of the way the Dodd-Frank law was written, if the Fed doesn’t issue
a final rule by that date, its proposal to cap the swipe fee at 12
cents will become law.
In the meantime, bank lobbyists are racing to
build bipartisan support for a Senate bill that would effectively
kill the swipe fee cap by delaying it for at least two years.
The bill, introduced by Democrat Jon Tester of
Montana, is supported by about 55 senators at the moment – not
quite enough to reach the 60 votes needed to overcome procedural
objections and move to a floor vote, with time running out on a
Congress eyeing a July recess.
So, with a multitude of optional outcomes
still possible, issuers and associations are hedging their bets on
what life after the Fed’s rules are announced will look like,
hoping for the best – the Tester bill’s two-year delay – while
preparing for the worst.
In a call with analysts and reporters to
discuss second-quarter earnings, MasterCard president and CEO Ajay
Banga said the industry is unlikely to feel the full impact of the
Fed’s rules until at least 2012.
Issuers “are looking at reducing the reward
levels on their debit card activity,” Banga said, adding that many
of the changes issuers are considering would work to limit
consumers’ debit card use, which certainly would have a deleterious
effect on the association’s bottom line.
“They’re looking at fees on debit cards,”said
Banga.
“They’re looking at restricting the manner in
which debit cards get used, either for large-ticket items because
of concerns around fraud losses or at the bottom end for
small-ticket items.”
The Fed’s rules also are likely to force rapid
adoption of a dual interchange environment, with the smaller
issuers exempted from the rules enjoying higher rates while the
larger issuers struggle under the lower rates mandated by the
Dodd-Frank law.
Visa already has announced that it will
support a two-tiered interchange system to accommodate higher
interchange rates for smaller financial institutions. MasterCard
has not yet said whether it would support a two-tiered rate
structure.
Re-examining incentives
In a similar conference call discussing
earnings, Visa executives said they are likely to re-examine
incentive agreements with issuing banks after the Fed announces the
final interchange rules.
“We will naturally, at our impetus, want to
revisit a number of those contracts to make sure that the
incentives are structured in a way that makes sense, given the
legal environment that we will be under post-Durbin,” Byron
Pollitt, Visa’s CFO, said in the call.
The American Bankers Association said in April
that the Fed’s proposed 70% cut in debit processing fees means
banks will lose money on every transaction. The only options left
will be to shift these costs to consumers or cease providing debit
cards, said ABA president Frank Keating.
That would send larger issuers into a
fee-hunting frenzy, the broad contours of which already can be seen
in some of the moves made recently by some of the nation’s largest
debit issuers.
First steps to change
ATM fees are a natural pivot point for large
issuers seeking to recoup lost interchange revenue, a possibility
illustrated by JPMorgan Chase’s recently concluded test of $4 and
$5 ATM fees for non-customers in some areas. While the bank has
decided not to apply these fees nationally, and reverted back to
its original $3 fees, the trend is catching on.
HSBC Bank USA started charging all
non-customers a $3 fee in March for using its ATMs. Previously,
about 40 percent of its ATMs charged either $1.75 or $2.50.
TD Bank used to let customers use any ATM free
of charge, but the bank is now charging $2 for customers who use
out-of-network ATMs — unless the customer has a “deeper
relationship” with the bank, defined as carrying a high minimum
balance and paying a monthly fee of $25.
Late payments may soon automatically trigger
dramatic interest rate increases – a move permitted under the new
credit card reforms. Bank of America customers who make late
payments on their credit cards may soon see their interest rates
jump by 30% in the first instance of what may become a standard
tactic among US banks.
Beginning 25 June, the nation’s largest credit
card issuer will charge a penalty interest rate of up to 29.99% on
future balances for credit card customers who fail to make timely
payments.
Other issuers, including Chase and Citi, are
already charging penalty rates ranging as high as 29.99%.
Lowering value
The new Fed rules could also spell the end of
debit card purchases greater than $100, or even as low as $50. The
revenue banks get from interchange fees helps to offset money lost
from fraudulent transactions. So with the Fed’s proposed cap in
place, banks argue they won’t have the money to protect themselves
against fraud for larger transactions. JPMorgan Chase has said it
is considering capping debit card transactions at either $50 or
$100, and other larger issuers are sure to consider such a move as
well.
The most obvious, and often-discussed, victim
of life after an unregulated interchange market are debit rewards
programmes, a popular offering among larger debit issuers quickly
going extinct even before the Fed’s rules are finalised.
Wells Fargo is no longer offering its debit
rewards programme for new customers. JPMorgan Chase notified
existing customers that their debit rewards programmes will
disappear July 19. The bank eliminated debit rewards for new
customers in February.
SunTrust Banks Inc. also began notifying its
customers that it will stop offering rewards on purchases with one
of its debit cards starting April 15. Customers will have until the
end of the year to redeem earned points.
Even smaller debit issuers dislike the
interchange cap. The 2011 Debit Issuer Study, commissioned by
Pulse, concludes that small debit card issuers, including community
banks and credit unions, on average expect a 73 percent decrease in
debit interchange revenue as a result of pending interchange fee
rules.
While these issuers with less than $10 billion
in assets are exempt from the regulations proposed by the Federal
Reserve Board, they are critical of the interchange cap and
skeptical that the exemption will be effective.
“The study results support broad industry
consensus that the proposed interchange cap will likely affect even
exempt issuers. However, the impact small issuers say they are
expecting is greater than many anticipated,” said Steve Sievert,
senior vice president of Pulse, which has commissioned the study
for the past six years.
Additionally, many issuers indicate they will
encourage increased use of PIN debit instead of signature debit,
contrary to what many have done in the past. Following
implementation of the proposed rules, with interchange rates for
PIN and signature debit transactions likely being the same for
regulated issuers, PIN transactions will have a better bottom-line
contribution for issuers.
As all parties await the Fed’s final rules,
one thing is certain: change is inevitable.
