Visa Europe’s agreement to cap cross-border debit fees at 20 basis points in April heaped more pressure on banks’ debit card businesses. Will Cain looks at how the industry has responded to declining margins on their debit products and the most effective ways to measure profitability
Innovation, process efficiency and the need to evolve business models are themes present throughout the cards industry, and this is particularly the case for the debit payments businesses.
This is being driven by ever-changing regulations which are pressurising both debit and credit card industry profitability. It is not new that financial services businesses are being forced to change as a result of regulation – in fact it is the one of the few things they can depend on in the current financial environment.
Regulatory change has been more sudden in the credit card world, where recent changes, notably in the US, have represented some of the most wide-ranging reforms the industry has ever seen.
In debit card payments, regulatory pressure has been of a more ongoing nature, with EU and US investigations into interchange fees. On 26 April this year, the European Commission and Visa agreed to cap interchange, the fee paid by an acquiring bank to a card issuer on each card transaction, at 20 basis points for cross border debit transactions in the EU.
The cap also applies to so-called “immediate debit interchange fees” on domestic transactions in Greece, Hungary, Iceland, Ireland, Italy, Malta, Sweden, Luxembourg, and the Netherlands.
Opportunities despite pressure
Clearly, margins in debit are under pressure, but there are also opportunities because a sizeable proportion of low value transactions are being performed using cash and cheques.
“The current environment is risk averse, lending is in decline,” said Maria Lorenzo, head of payments at Spain’s Banco Popular. “Debit brings an opportunity to all of us. It means we can provide a payment method to new and existing customers and for the consumer this means they have more control.
“Last year, across many markets, debit proved a resilient payment mechanism compared to credit. Nevertheless it is a low-margin transaction which requires high volume to make it profitable.”
Lorenzo cited examples from the Spanish market, which has around 70m cards in circulation. The majority of growth over the past 10 years has been in credit, with debit stagnant in terms of volume increases. In 2000, debit volume stood at around 65% of the entire cards market, compared to around 45% today.
In terms of the number of transactions, credit overtook debit four or five years ago. The share of debit transactions in the market has gone down from 56% to 45%.
“In terms of volume, it’s interesting,” said Lorenzo. “Even though of course credit rapidly surpassed debit in the last 10 years, the gap is not any higher than would be expected. This is more to do with the fact that in Spain, banks have not been able to activate and generate spending on credit products.
“Also, in the last five years, debit interchange has been under pressure, so we have not been pushing debit so much at the POS and have been pushing credit instead.”
The average transaction for debit has grown very little over the past 10 years, according to figures quoted by Lorenzo. It has increased from €39 ($50) in 2000 to €43 in 2009.
“What has really been dramatically dropping is the average transaction on credit card product, and this is a good thing, because it means people are using them to pay for low value items as well as the large items traditionally favoured by consumers on credit,” she said.
“The fact that the average transaction for debit has not dropped faster shows we have not been able to penetrate those cash-intensive industries where people prefer cash to cards. I believe this is an opportunity for debit.”
Spain is a competitive market for cards with 4.9 cards per household, out of which 1.9 are debit. Increasing the activation and level of spend on these cards is seen as the key challenge.
New entrants and youth clients are considered one of the most important areas of potential new clients for banks looking to grow market share in both debit and prepaid. As there is less financial information available on these clients, the extension of basic payments products is seen as a less risky way of engaging with these types of customers.
“These types of purchases tend to be done locally and there may be an element of remittances here as well with migrant workers sending funds back home,” added Lorenzo.
In the youth segment, debit innovation in the Spanish market has included the doubling up of debit cards as an identification tool at universities. Payments can also be made in a closed circuit in the university, or in an open loop outside.
The mass market is fairly generic, Lorenzo added, although within this the retirement population is important and growing. There is evidence they prefer debit products to credit.
Another important segment was businesses, she said, particularly small and medium-sized companies, which often have a preference for debit. Tailoring products to the high net worth segment, which tend to be a bank’s most profitable segment, is also an important area.
“Among high net worth individuals, it is too easy to give them a gold card, premium bank account and forget about them,” she said. “Segmenting these clients will make them profitable for you.”
One of the primary means of extending profitability is through network expansion. This can drive volumes, and debit and prepaid offer a way of doing this in different markets with less financial information about the clients.
By extending networks and acceptance infrastructure, debit cards can also replace cash payments.
“It really depends where you are coming from,” said Lorenzo. “People say debit has low margins, it makes us less money. And of course, if you are coming from lending-based products, debit at this point has lower margins. However, if you are talking about cash, debit has a lot to offer. For example, in markets that are cash- or cheque-intensive, a move to debit would show good profitability measures.”
One area of particular importance in migrating cash usage onto debit is increasing the use of cards at the point of sale. In 2000, around 65% of transactions on debit and credit cards were ATM or branch cash withdrawals, a figure which had reduced to 55% by 2009.
Lorenzo said this has been a particular focus at Banco Popular. She added that the ability to build relationships with customers through debit as their primary payment mechanism was one of the key drivers of value.
“Profitability depends on transformation,” she said. “It is about how we can transform debit transactions, with declining margins, to be a profitable business through relationships.
“I am not saying it is magic. Debit transactions are under pressure and we cannot achieve profitability easily. It is not going to be transaction but the relationship where we will get margins and profits. We have to look at cost. As banks, we have focused a lot on increasing our revenues, but we also need to look at cost. How can a processor help us reduce those costs will also be a consideration. The way to transform these businesses is about developing segmentation, innovation and increasing usage.”
With interchange pressures and relatively inflexible cost bases, debit margins look unlikely to improve. There are of course some exceptions – notably India, where debit interchange averages above 200 basis points – but for the majority of markets, generating profitability from debit lies increasing volume rather than margin.
The other way to approach debit is through the concept of bank-wide loyalty, cross-subsidising the costs of debit programmes with the ability to build margin in other bank departments. Lorenzo said insurance products were a good example.
“Margins will improve through enhancing the relationships with our clients through cross-selling of insurance products, which can generate 20-30% margins to debit products within a year,” she said.
“New services are also important – remittances for the unbanked is one example.”