As credit cards become more expensive
for consumers – and as credit losses continue to mount for the
banks that issue them – debit card issuers are reaping the benefits
of increased usage. But how are issuers generating profit in a
tumultuous economic environment? CI

If there is one bright spot to be found in the economic woes
engulfing payment card players at the moment, it is that debit card
usage is continuing to climb in all global markets as consumers
rein in credit spending.

A look at the latest financial results from Visa and MasterCard
(see CI410) underlines the fact that debit usage is
continuing to see healthy double-digit growth rates, even in the US
where consumer spending has been hit the hardest. Although debit
payment volume growth is slowing slightly, Visa and MasterCard both
highlighted debit as far outstripping credit card volume

There are plenty of recently published studies that also confirm
consumers are turning to debit in ever greater numbers. The most
recent, from the National Retail Federation (NRF) of the US,
conducted a survey of shoppers about their intended payment habits
in the run-up to the 2008 Christmas holiday season. According to
the NRF’s survey, 41.5 percent of consumers surveyed expect to use
debit cards as their primary method of payment, up from 40.1
percent in 2007, while use of credit cards as the primary payment
method is expected to fall to 31.5 percent, down from 32.3 percent
in 2007.

That trend is being mirrored across the world. In the UK,
payment industry body APACS recently reported that in the third
quarter of 2008, there were 1.9 billion plastic card purchases
totalling £93.7 billion, with debit cards accounting for 73.8
percent of all plastic card purchases, compared with 72 percent in
the third quarter of 2007.

But how is the industry turning this increased usage into
greater profit, and are issuers making any profit from debit card
usage at all? With credit card profits being hammered relentlessly,
and with the outlook remaining gloomy for credit card issuers for
the foreseeable future, what strategies are debit card issuers
deploying in the debit card space?

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Profits on debit card usage come nowhere near the levels of
profitability seen on credit cards, given that issuers cannot
charge interest and rely mostly on fees, while interchange levels
on debit cards can be three times lower than credit card
interchange. Because of this, debit generates a much lower level of
fee revenue per transaction.

Debit rewards

Interchange is one of the components that funds debit rewards
schemes, which on the whole, tend not to have the same level of
rewards on offer with credit card rewards schemes. But this has not
stopped issuers from expanding debit rewards offerings with the aim
of deepening customer loyalty, which is all the more important in
the current economic climate.

According to US payment consultancy Mercator Advisory Group,
financial institutions are expanding and diversifying debit reward
programme offerings – around two-thirds of the top 50 US banks
currently have at least one reward programme in place, and nearly
half of these financial institutions offer multiple loyalty
programmes to debit cardholders.

Most debit loyalty programmes at the top 50 banks only reward
signature-based transactions, while a select few reward both
signature and PIN-based transactions. Most of the reward programmes
are funded by interchange revenue, which is substantially greater
for signature than PIN debit transactions, but significantly less
than credit card transactions. As such, most debit reward
programmes are less lucrative than their credit card

A spate of debit card offerings, such as those that round up
debit card purchases to the nearest dollar and automatically
deposit the change into a linked savings account, have been
launched over the past year, and according to Mercator, rewards
that promote savings and cashback are the most popular type of
debit reward programmes, especially since many consumers are facing
financial challenges and are increasingly using their debit cards
as their primary payment tool.

Some debit issuers are also looking at exploring the potential
of offering debit solutions to consumer groups who would normally
be classed as the least active group of debit users.

According to MasterCard, people who earn over $75,000 a year are
the least active debit users – this type of affluent consumer is
more likely to use their credit card to accrue premium travel and
entertainment benefits such as frequent flyer miles and other

Bringing merchants into the loop

It is likely merchants will also play a bigger role in the debit
rewards space in partnership with financial institutions to create
programmes that enable the merchant to underwrite rewards
programmes, or via more unconventional co-branding relationships
which are also gaining traction in the debit space.

In this way, merchants will also have an incentive to encourage
debit usage at the point of sale and to boost the volume of debit
transactions – a win-win for both the merchant and the issuing

According to Mercator: “The biggest banks are the biggest card
issuers and they will slug it out between each other as smaller
issuers try to protect their existing portfolios while poaching
from their big new neighbours.

“We will see the roll-out of impressive new national
merchant-funded discount networks that will feature huge national
brands and strong regional retailers in a Chinese menu of discount

In October, MasterCard launched its ‘Savings’ debit reward
programme to tap into this market, offering debit cardholders
discounts on premium luxury brands. Another trend, which has become
all the more noticeable in recent months, is that debit card
issuers are starting to hike fees on some aspects of debit card
usage. The most common fees associated with debit cards are ATM
fees and fees for specific transactions such as foreign

Banks can charge for the use of debit cards at ATMs, typically
when a cardholder uses their card at another bank’s ATM. The
issuing bank charges a fee that is either a percentage of the
amount withdrawn, a fixed amount, or a combination of the two.
Banks can also charge fees for using additional services at a rival
bank’s ATM, such as bill payment.

According to of the US, fees for withdrawing cash
from rival ATM networks rose in 2008, with the average cost of
using another bank’s ATM now $3.43, compared to $1.97 in 1998. The
$3.43 average ATM fee included the surcharge levied by the ATM’s
owner for non-account holders ($1.97) as well as the fee banks
charge for using an out-of-network ATM ($1.46).

It is likely that ATM fees will continue to rise in 2009, and
some banks will look at charging more for associated ATM services
such as ATM statements. And it is not just a US phenomenon. In
Thailand at the start of this year, a number of banks increased ATM
withdrawal fees by as much as 70 percent, justifying the increase
by saying that the costs of transporting cash and maintaining ATMs
had risen along with energy and electricity costs.

But it is overdraft fees that reap in a major proportion of
debit card revenue for issuers. As debit cards are linked to a
customer’s current account, transaction authorisations are
dependant on the cardholder having enough funds in their account to
pay for the purchase. found that in the US, overdraft
fees now average $29, up 3 percent from 2007.

Not only are overdraft fees going up, but the way that issuers
authorise transactions is also changing. In years gone by, banks
would typically deny debit purchases if insufficient funds were
available in the cardholder’s account, but more and more banks are
now approving transactions but at the same time charging the
cardholder an overdraft fee if they exceed funds, in much the same
way that fees are charged when cheques are bounced.

Also, some issuers are charging overdraft fees as soon as the
purchase is made, whereas previously, cardholders had a grace
period of two to three days before the transaction cleared. This
has not gone unnoticed by consumer groups in the US.

“Banks have turned to this as a major source of revenue,”
according to Jean Ann Fox, director of financial services at the
advocacy group Consumer Federation of America (CFA).

According to the CFA, consumers paid $17.5 billion a year for
unauthorised overdraft loans that stemmed from not keeping track of
their debit card purchases.

In early November 2008, Citi began charging some customers a new
$10 ‘overdraft protection transfer fee’ to transfer money from a
savings account or line of credit to cover shortfalls in chequeing
accounts, having already raised foreign exchange transaction fees
on debit cards. Other banks have introduced fees for customers who
use their debit cards to withdraw cash at branch counters instead
of at ATMs, while Washington Mutual, which is being acquired by
JPMorgan Chase, has raised its overdraft transfer service fees from
$10 to $12.

Opportunities in an uncertain era

With the global economic turbulence frightening consumers away
from spending on credit, issuers are increasingly positioning their
debit card offerings as budget management tools.

Part of the reason for debit’s gain on credit in recent times is
that consumers value the ability to monitor and control their
spending – an ability that will take on increasing importance in
the current climate. Debit issuers, who by and large are
positioning debit cards as tools for everyday low-value purchasing
tools, would be wise to highlight the cost-control aspect of debit
cards to their customers in their marketing plans, which would also
help to increase activation rates, resulting in lower acquisition
costs per customer.

Consumers are at risk, however, if they use their debit cards in
the same way as credit cards, for example by racking up consecutive
large-value purchases on their cards in the same way that they
would run up large balances on their credit cards. This would
result in consumers going overdrawn more often and incurring higher
and higher overdraft fees.

Obviously, banks are aware that new fees and fee increases are
never going to be popular with customers, particularly at a time
when debit card usage is gaining in popularity as consumers become
more budget-conscious.

A new era of economic uncertainty and increased pressure on
costs may have left some issuers with no choice in the matter,
especially smaller banks with lower capital bases. Average per
transaction costs for larger financial institutions are much lower
than smaller financial institutions, as much as 80 percent in some
cases, derived from economies of scale in processing and
back-office costs.

Some banks are already experimenting with ‘tiered’ pricing
structures for current account services, such as imposing lower
penalties for exceeding an overdraft for the first time, but
increasing the charges for every incidence thereafter.

The recent wave of mega-bank mergers could provide larger
issuers with the opportunity to further drive down the costs of
card customer acquisition, thanks to the expansion of branch
networks and integration of technology and customer service
functions. But it is also likely that this consolidation could see
the larger issuers imposing even larger fee increases throughout
2009 and beyond, as competition in the market is reduced, leaving
customers with less choice.

Issuers themselves argue they are now in a completely different
operating environment than a year ago, and have to position
themselves aggressively to retain and recruit customers.

Debit card usage