By Patti Murphy
The Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 struck the acquiring sector like a bolt of lightning, forcing banks to scramble to come up with new models to support once lucrative debit card programs, and to do so by Oct. 1, 2011.
"As a result of the Durbin Amendment, the payments industry will be forever changed," said Madeline K. Aufseeser, Senior Analyst at Aite Group LLC. "Debit and prepaid card issuers are grieving over significant losses in revenue and the added expense of making it all work."
But the news isn't all bad. Some ISOs and acquirers could see revenues increase once debit interchange is capped, as mandated. So, too, could merchants, or at least those that negotiate to ensure they get the new, lower rates.
Robert O. Carr, Chairman and Chief Executive Officer of Heartland Payment Systems Inc., told a meeting of restaurateurs (a key niche for the company) that Heartland's average restaurant customer will save nearly $2,000 a year from lower debit interchange fees. Carr's remarks came before the Fed's final rules were issued; analysis of the final rule indicated interchange fees would be cut by about 40 percent.
"I've had conversations with ISOs who see this as a revenue opportunity," said attorney Adam Atlas. That's because nothing in the legislation or the Fed's regulation requires ISOs to pass along to merchants the savings from reduced interchange assessments. Acquirers and ISO-acquirers that have accounts with national and large regional chains aren't apt to be able to pocket the savings, since many of those businesses are active in the campaign against interchange and are on the lookout for tangible savings.
Likewise, merchants benefitting from lower debit card interchange fees are not required to pass their savings on to consumers, although at least one convenience store franchisee expects consumers will reap financial benefits from the new rules.
"The cost for a debit card transaction for the average store will decrease by almost half," said Bruce Maples, Chairman of the National Coalition of Associations of 7-Eleven Franchisees, in an interview with the website Payments.com on July 11. "The reform will save each franchisee in the country almost 50 percent of the cost of a debit transaction, which ultimately will be passed on to the customer, in an effort to be more competitive, or used by the franchisee to grow their business or hire new employees," Maples said.
Carr had a similar message during a July earnings call. "We are the company that is going to send every single dollar that was mandated in the Durbin legislation to the place it was intended: to our merchants' bank accounts," he said.
The Durbin Amendment (named for Sen. Dick Durbin, the Illinois Democrat who authored the amendment) instructed the Federal Reserve Board to cap interchange fees on debit card payments at a rate it deemed "reasonable" and "proportional" to the costs of clearing and settling those transactions.
As a result, beginning Oct. 1, 2011, debit card issuers can charge only 21 cents plus 0.05 percent of the transaction in interchange. Issuers that can prove they went the extra mile to protect against fraud may collect an extra penny per transaction in debit interchange. By the Fed's reckoning, the new rules mean the most an issuer could charge would be 24 cents on the average debit card payment, which the Fed puts at $38.
The legislation and implementing regulations also require that merchants be given a choice of at least two unaffiliated networks (for example, Visa Inc.'s and MasterCard Worldwide's) through which to route debit card payments for processing. Banks with technologically challenging card programs get until April 1, 2012, to be in full compliance. Also, all-electronic prepaid card programs (no check-writing privileges) are exempt.
The 21-cent cap the Fed decided on is a far cry from what issuers collect today in debit interchange - 44 cents per transaction on average - but a substantial improvement over the 12-cents-per-transaction ceiling the Fed originally proposed. The original proposal amounted to a 70 percent reduction in interchange per transaction, according to industry estimates.
Retailers had been complaining about interchange rates for years, yet few outside the merchant and banking communities had any understanding of the issue, or had even heard of card interchange. That is until several merchant groups came together under the banner of the Merchant Payments Coalition and launched a grass roots campaign against "swipe fees," the catchy moniker that has become popular among retailers.
The two lawmakers whose names appear on the legislation - Chris Dodd, former Democratic senator from Connecticut, and Rep. Barney Frank, D-Mass. - have both publicly complained about the Durbin Amendment. In fact, at the Electronic Transactions Association's Annual Meeting & Expo in May 2011, Dodd said he was surprised the final legislation included Durbin's amendment. "We really didn't expect it to pass," he said.
But it did, and the Fed, which had only a year to come up with rules implementing the new law, has been taking flak from all sides. "The Fed's rule is an irresponsible abdication of its legal duty to implement the law," said Lyle Beckwith, Senior Vice President of Government Relations at the National Association of Convenience Stores. Beckwith is a founder of the MPC.
Adam Levitin, Professor of Law at Georgetown University and a vocal champion of interchange price controls, complained the final rules amount to a $4 billion a year gift to banks. "That's $4 billion that will be added onto the cost of goods and services consumers purchase, meaning a wealth transfer from families to the 100 biggest banks of roughly $40 per family per year," he wrote in a recent blog posting.
Mallory Duncan, General Counsel at the National Retail Federation and Chairman of the MPC, said the final rule was "unacceptable to Main Street merchants and consumers who were counting on the Fed to issue a fair rule that followed Congress' law."
The National Association of Federal Credit Unions doesn't like the new rules either. "To be clear, this is not a big bank issue," the Arlington, Va.-based trade group said in recent letter to lawmakers. "This is an issue about consumers and community institutions such as credit unions." The letter was written in support of legislation to postpone the effective date of the Durbin Amendment; that legislation failed to pass.
Aite's Aufseeser expects large banks and the card companies will be hard hit by the new fee caps. "Meanwhile, the consumer stands to be the biggest loser," she added. "Banks will likely raise the direct cost of banking to make up for lost revenue, while merchants are unlikely to pass any of their savings on to consumers."
Consumers are already starting to feel the pain, as several financial institutions are implementing plans to curb rewards programs. JPMorgan Chase & Co., the second largest issuer of debit cards, told cardholders earlier this year it will end popular debit card rewards once the new rules kick in, including airline miles and cash back offerings.
USAA Savings Bank, a large credit union serving veterans and their families, told members it will end debit card rewards effective Sept. 1, 2011. "Unlike other banks responding to the new law, USAA Bank is not adding fees or eliminating benefits that members value most, including free checking and ATM free withdrawals," Aufseeser said.
A recent survey of consumers undertaken by the website Bankrate.com revealed 64 percent of respondents would consider switching financial institutions if those institutions were to raise fees on checking accounts.
The research and ratings agency, Moody's Investors Service Inc., agrees big banks will be big losers, but predicts less red ink now that the Fed has set the cap at 21 cents instead of 12 cents. The higher cap will save banks about $3.5 billion, Moody's reported. The Fed's original proposal for a cap of 12 cents would have cost the industry $11 billion-plus, analysts said earlier this year.
Moody's said Bank of America Corp. and Wells Fargo and Co. will be hit hardest (to the tune of about $1 billion a year) but should be able to recoup those losses through other products and services. In filings with the Securities and Exchange Commission in July, BofA, which boasts more checking account customers than any other bank in the country, told investors its annual costs would be closer to $2 billion.
In late July, Visa reported it may not be hit as hard by the Durbin Amendment as it had originally expected. The company had warned investors earnings increases would likely remain in the single digits during fiscal year 2012, but in late July it revised that forecast and projected earnings in fiscal year 2012 of between 11 percent and 13 percent, according to published reports.
Visa CEO Joseph Saunders said in a call to investors that the card company is working on strategies to keep it a preferred processing network after Oct. 1. "Providing some level of incentives to specific merchants may be an effective strategy to ensure Visa continues to receive routing profits," he said.
First Data Corp. owns the STAR Network, which handles ATM and POS transactions. The company counts as clients both card issuers and acquirers, as well as ISOs, and it isn't overly concerned about the financial impact of the Durbin Amendment.
Ed Labry, President of First Data - North America, said in a prepared statement the company has been busy developing new programs to help "comply with the changes resulting from the new regulations. These include reinvesting in the STAR Network; routing programs to negotiate effectively with other payment networks; and near-field communications (NFC) technology for use at the point-of-sale for the future of payments acceptance."
Moody's predicted TCF National Bank would be a winner under the new interchange regime, but executives at the Wayzata, Minn.-based bank aren't celebrating just yet. In a July conference call with investors, the bank's President and CEO, William A. Cooper, said TCF expects to lose $50 million to $60 million a year in debit card fee revenues. He said he is hopeful, though, that new products and services to be introduced in the fourth quarter 2011 will help staunch those losses.
TCF, an $18.7 billion bank, earlier this year took the Fed to court in an unsuccessful bid to halt or delay implementation of the Durbin Amendment. When the bank dropped the suit, Cooper fired one last salvo at Washington and proponents of interchange caps. "We continue to believe that the Durbin Amendment is unconstitutional because it requires below-cost pricing and exempts 99 percent of U.S. banks," he said.
The debit card market is huge and growing. According to the 2010 Federal Reserve Payments Study, debit cards are the fastest growing way to pay when it comes to noncash. In 2009, U.S. consumers made 37.9 billion payments using debit cards - a 14.8 percent jump over the 25 billion debit card payments made in 2006. Credit card payments totaled 21.6 billion in 2009, down slightly from 21.7 billion three years earlier.
The latest monthly analysis of card spending by First Data shows dollars spent using signature debit cards grew 8.5 percent in June. Dollars spent with PIN debit were up 6 percent, according to First Data's June SpendTrend which analyzes traffic on the company's processing networks. Credit card usage, meanwhile, was up 10.7 percent in June, First Data said.
A survey undertaken in early July by the Associated Press found nearly two-thirds of respondents use their debit cards more often than credit cards. However, when asked what they would do if their banks charged them $3 a month to use debit cards, 61 percent said they'd find another way to pay. Among consumers who would scale back on debit card usage, 53 percent said they'd pay with cash instead, 42 percent said they'd start writing more checks, 22 percent said they'd use credit cards and 12 percent said they'd switch to prepaid debit cards.
Generally, prepaid debit card interchange is subject to the Durbin Amendment. Only fully electronic prepaid debit card programs are exempt from the law. To be fully electronic, a prepaid program can offer no check-writing privileges, nor can the cards be used in most electronic bill-payment programs, which use the automated clearing house system to route payments.
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