The issue of how to generate profit on debit cards is a
long-standing one that issuers have grappled with. As more
consumers turn to debit at the expense of credit, which fees are
being hiked up? And how will a rising tide of regulatory pressure
impact profitability strategies? Victoria Conroy reports.

 

Up until a few years ago, debit cards were viewed as loss-leader
accompaniments to current accounts, with little clarity on how
transaction costs contributed to overall current account profit and
loss ratios, and issuers had limited incentive to actively promote
their usage.

However, with the growing worldwide consumer
shift to debit over credit, which is boosting the volume of funds
in consumer current account deposits, and the economic turbulence
of the last two years incentivising consumers to gain more control
over their everyday spending, issuers are increasingly positioning
the current account debit card as a crucial customer acquisition,
retention and cross-selling tool.

And, in light of banks’ credit card profits
taking a hammering due to rising credit losses and provisions, some
issuers are also using this new age of austerity to hike up fees on
debit card-related services in a bid to recoup lost revenues.

Refocusing on fees

As debit cards are not a stand-alone
proposition but one component of the current or checking account,
banks have chosen to overhaul the wider fee structure covering
those accounts. The most common direct revenue sources associated
with debit cards are interchange, ATM fees, annual fees, issuance
and card replacement fees and fees for specific transactions. But
overdraft fees have become a crucial source of income for bank
issuers – even more so in the current financial climate.

Up until the turn of the decade, banks would
usually decline to authorise debit purchases if the cardholder did
not have enough money in their account, but these days a growing
proportion of banks will approve transactions but then charge
overlimit or overdraft fees if cardholders exceed their available
funds.

Another big change is that previously, those
cardholders would not be charged overdraft fees until two to three
days after the transaction, the time it takes for debit
transactions to clear, giving them an opportunity to deposit funds
into their accounts. But now, a growing number of banks are levying
fees as soon as the transaction is conducted.

A 2009 study of US checking account fees by
market research firm Bankrate found that one of biggest trends in
fee increases is ATM surcharges, which rose 12.6 percent from 2008
to an average of $2.22. Bankrate found that banks increasing the
fee outnumbered those reducing the fee by more than a 7-to-1 ratio.
ATM surcharges have increased at an annual rate of 7 percent over
the past decade.

Monthly service fees this year hit a new high
at an average of $12.55, up nearly 5 percent from 2008. Another
growing source of fee income is tiered structure fees for
overdrafts, with 26 percent of US banks surveyed by Bankrate now
charging higher fees after the second overdraft during a rolling
12-month period, with higher fees again for each subsequent
overdraft.

On the consumer side, a study from the US
Center for Responsible Lending (CRL) found that over the past 12
months, a quarter of US consumers with bank accounts had paid
overdraft charges, with financial institutions reaping almost $27
billion in such fees in 2008, a 35 percent increase from 2006.

Overall, over 50 million US consumers overdrew
their checking account at least once in 2008, with 27 million
accountholders incurring fees for doing so five times or more. With
the US economy only just beginning to claw its way out of
recession, the CRL is estimating that the $23.7 billion in
overdraft fees reaped by banks in 2008 could rise to $26.6 billion
by the end of 2009. The irony is that as consumers have reined in
their credit card spending, they have become more reliant on debit
cards for everyday spending and an increasing number of low-value
transactions are being made, which puts consumers at greater risk
of going overdrawn.

Regulatory scrutiny across the
world

The spotlight is now shifting to
banks’ current accounts – with a particular focus on debit cards –
and not just in the US. A rising tide of populist consumer and
political pressure is urging greater regulatory oversight on how
issuers calculate overdraft fees. In recent weeks, US banking
giants Bank of America (BofA), JPMorgan Chase and Wells Fargo among
others have announced reductions in their overdraft charges,
following similar moves made by banks in Australia.

The US Senate and Congress are examining bills
which would require consumers to opt in to overdraft schemes,
rather than being automatically enrolled by financial institutions.
A 2008 study from the Federal Deposit Insurance Corp (FDIC) found
that 41 percent of US banks have automated overdraft programmes,
and among large banks that figure was 77 percent.

Meanwhile, in the UK, banks are also cutting
unauthorised overdraft charges ahead of a landmark court case
brought by the Office of Fair Trading (OFT) watchdog, which is
expected to be heard in the next few weeks.

The personal current account market in the UK
was recently the subject of an in-depth report by the OFT.

The OFT’s report found that during 2006, UK
personal current account providers earned £2.6 billion ($4.3
billion) from unarranged overdraft charges, representing
approximately 30 percent of their revenue from personal current
accounts.

The average amount incurred was £205 per year,
although £500 or more was not uncommon. In 2006, the average daily
unarranged overdraft balance was £680 million, yet revenues raised
in relation to item and maintenance fees came to £1.5 billion, or a
return of over 220 percent on the balances.

The situation in Europe

Across Europe as a whole, bank fees
have also been recently scrutinised by the European Commission
(EC). In 2003, 80 percent of consumers in 15 European nations had a
current account including a payment card or cheque book, but by
2008, 87 percent of consumers in 27 European national had a current
account.

The EC, which examined price levels
across the European Union, found that the problem of opaque tariff
structures is something that is pervasive across the continent and
signifies a trend of consumers often paying more than they had
intended in bank fees.

The study analysed a sample of 224 banks which
cover 81 percent of the retail banking market in terms of customer
deposits and which are representative of the diverse banks in the
EU. Price divergence for bank accounts at the EU level is higher
than the variation of prices of other services across the EU. The
divergence of prices of current accounts is also higher from one
member state to the other than domestically, meaning that consumers
in some member states pay considerably higher current account
charges than in other member states.

For example, the prices of the more intensive
users’ accounts range from a high of €831 ($1,242) in Italy to a
low of €28 ($42) in Bulgaria. Regardless of the intensity of usage,
countries which are consistently at the higher end of the price
distribution range include Italy and Spain. Also, the average
prices for Austria, France and Latvia are higher than three
quarters of the countries included in the analysis.

The implementation of the Payment Services
Directive (PSD) (see CI 426) on 1 November, a European-wide
harmonisation initiative designed to bring about a more level
playing field, has been hailed by national and pan-European
regulators as a major transformative measure as it also has the aim
of improving consumer choice through transparency and enhanced
competition.

Although the PSD in itself does not address
fees applied to payment services, the overall expectation is that
enforcement of greater transparency will impact consumer behaviour
as a consequence of an increased awareness of charges, like foreign
exchange surcharges, that may have otherwise gone unnoticed.

Seven EU member states, including the UK,
France, Germany, Denmark, Bulgaria and Austria have completed
transposition already, but other countries are still to pass it
through their respective parliaments, and there are lingering
questions as to how the PSD will be transposed into national law,
and whether there will be any consistency or harmonisation
improvements as a result.

And some in the banking industry are not so
sure the PSD will make that much difference. A recent survey, The
State of the European Payments Marketplace – the Outlook for SEPA
and the PSD, by the Financial Services Club, has cast doubt on the
viability of both the PSD and the wider SEPA initiative.

The survey of European payment players found
that 58 percent of survey respondents think that the PSD is being
transposed inconsistently, with only 13 percent believing it is
being implemented correctly. Even more pessimistically, 14 percent
said the main driver of the harmonisation programme is for the
‘benefits’, with 19 percent voting for the ‘cost savings’ and 15
percent for ‘increased competition’; but the single largest group
were the 38 percent who believe this is purely ‘politics’ being
driven out by the EC’s agenda.

On the basis of the survey findings, the
Financial Services Club stated that in conclusion, “the PSD is
flawed in both its drafting and transposition… the result is that
the PSD will not support an integrated and harmonised European
payments marketplace until 2013 or beyond.”

With many countries not predicted to return to
normalised economic circumstances until 2011 at the earliest, it
appears that regulatory headwinds across the world will converge to
push retail banking profitability even lower in the short term,
which means that banks now face an ever-shrinking window of
opportunity to derive as much revenue as they can from existing
fees before they are curtailed by outside forces.

Debit card profitability: Debit card
revenue sources

Direct sources of
revenue

• ATM fees, typically when using a
rival bank ATM

• Annual fees (usually attached to
loyalty programmes)

• Issuance and replacement fees for
new, expired or personalised cards

• Overdraft transaction fees

• Foreign exchange fees for
cross-border debit transactions

Indirect sources of
revenue

• Increased float income on
non-interest paying current accounts

• Substituting debit card
transactions for more costly payment methods

• Increased customer acquisition and
retention, share of wallet

• Added benefits such as loyalty
programmes and insurance

• Improved brand awareness and
strength

Source: CI

Average US checking account fees

Total overdraft fees collected by banks and credit unions