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The Green Sheet Online Edition

November 12, 2007 • Issue 07:11:01

Changes afoot for signature debit

By Ken Musante
Humboldt Merchant Services

Currently, rewards interchange categories apply only to credit card transactions. With its June 2007 interchange release, MasterCard Worldwide sought to provide a competitive alternative to Visa Inc.'s traditional rewards. Even with this change, however, neither Visa nor MasterCard have a rewards category for signature debit.

As a consequence, the rates for signature debit are less complex, and there are fewer categories available for qualifying transactions.

Some issuing institutions do offer rewards to their cardholders for debit usage, but those rewards are not funded by interchange. Issuers choosing to offer such rewards do so because they believe the benefit from those customers more than offsets the cost of the rewards.

In the driver's seat

Like it or not, however, the interchange landscape for debit is set to become more complex: I forecast we soon will have true interchange reward categories for signature debit.

Driving these rewards are the new innovations in debit from the decoupled Capital One debit card launched in June 2007. This new type of MasterCard-branded debit card enables merchants to issue co-branded debit cards linked to consumers' existing demand deposit accounts. Consumers do not need to change their existing bank relationship.

Funds are drawn from the consumer's account via automated clearing house (ACH). Capital One handles all risk management associated with ensuring funds are available.

In 2003, when the Wal-Mart Stores Inc. settlement brought about the separate interchange schedule for signature debit, the rates were set lower than credit interchange. While this may not have been articulated in the settlement document, I would suggest the reason they were scaled down is to account for:

  • Lower credit risk
  • Lower fraud risk
  • Lower cost of funds

Credit losses are lessened because the issuer is not extending credit beyond the funds the issuer has on hand in the depositor's account. Certainly there are overdrafts and fraudulent purchases, but banks have a solid history of dealing with overdrafts.

Fraudulent transactions are more quickly reported on a debit card than with a credit card because cardholders are more in tune with their deposit balance than with their credit line. Also, because funds are deducted from the cardholder's checking account, there is no carrying or interest cost to the issuer.

In the cat bird seat

Capital One is providing rewards to cardholders using its decoupled debit cards and could conceivably tie the credit card reward and the signature debit reward programs together. Doing so would provide an immediate benefit to cardholders, as both types of transactions would build toward the same reward.

I surmise MasterCard likes the idea: It could give a much needed boost to its signature debit program which has lagged behind Visa's.

Capital One will gain market share and interchange revenue, but its expenses will be in excess of a traditional signature debit program. Specifically:

  • Credit losses will be greater than a traditional signature debit program because Capital One will not have the same detail on a cardholder's balance.

  • Revenues will be lesser because Capital One will not receive the "funds credit" for the deposits on hand from their signature debit cardholders.

While it is difficult to quantify the exact additional cost, it will be more expensive. I foresee MasterCard recognizing this additional expense, yet wanting to reward Capital One for increasing MasterCard's signature debit programs.

I also foresee Visa following suit. Doing so will incrementally drive signature debit programs and increase signature debit interchange rates.

Further, I foresee the increase in signature debit interchange being specifically tied to rewards. If the card Associations move to incrementally increase interchange on decoupled cards, they risk alienating their existing issuers.

Attaching the interchange increase to signature debit rewards cards keeps a level playing field for existing issuers and further excites signature debit activity _ just like the credit card rewards program increased spending on credit cards.

Competitors that have taken advantage of the high credit card interchange and shifted transactions to their proprietary solutions will be able to do likewise with signature debit transactions. In the vanguard Additionally, brands like Gratis Card and Tempo Payments are striving to create a low cost alternative debit network. I envision their programs working much like the Capital One card, where the deposit account can be at any institution that processes ACH transactions.

The offer that these upstarts have for merchants is low-cost transactions. This in turn frees merchants to fund their own specific rewards that:

  • Are unique to their place of business

  • Entice further sales at that merchant location

Instead of rewarding the cardholder with an unrelated reward, merchants can offer two-for-one deals to drive volume and pay for marketing campaigns that are more tied to their line of business.

Regardless, in the not too distant future, we will be harking back to the good ole days _ when signature debit interchange was simple.

In the know

What can you do about it now? Understand signature debit interchange. These transactions now outnumber credit card transactions. Work with your processor to understand how debit transactions qualify under your tiers, and use this to your advantage.

Further, when the changes I've just predicted do come about, you will be more adept at understanding the impact and manageit accordingly. end of article

Ken Musante is President of Humboldt Merchant Services. Contact him by e-mail at kmusante@hbms.com or by phone at 707-269-3200.

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