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The Green Sheet Online Edition

July 10, 2023 • Issue 23:07:01

Payments, a retrospective:
Bankcard and beyond

By Patti Murphy

Like many of the folks I meet in this business, I found the industry quite by accident. Literally. I was at a conference hotel (not sure which city) when I happened upon a handout bearing the logo of a group called the Bankcard Services Association.

I had been writing about electronic payments for over a decade but had written little about credit card acquiring. Over the next few years, the BSA became the ETA, and I met Paul H. Green. An industry pioneer, he was keen on educating the next generation of "feet on the street," with a little mischief on the side. He created The Green Sheet Inc. to further both objectives.

I met Green through another industry legend, the independent consultant Paul Martaus. To my knowledge, Martaus did not have a financial interest in any business connected to bankcards, but he understood the business and the players better than most. Now retired, both men left indelible marks on this industry.

Bankcards, a 20th century innovation

Bankcard arrived in the 1960s, with the introduction of BankAmericard. Bank of America, after successfully launching the card, began offering franchises to the largest banks in major cities nationwide. At about the same time, a separate group of banks created a competing organization, MasterCharge.

Eventually, these became free-standing corporations, known as Visa and Mastercard. Initially, each brand was exclusive—a merchant accepted either Mastercard or Visa—but that anti-duality stance was dropped in the late 1970s.

Duality came to financial institutions (FIs), too, and helped fuel an explosion of credit card issuance. It also raised antitrust concerns, since many banks sat on the boards of both associations. The Department of Justice went after Visa and Mastercard in 1998 in the first of several antitrust investigations, which continue today.

Birth of an industry: merchant acquiring

It took about 15 years before merchant acquiring emerged as a standalone business. That's how long it took FIs to accept that selling card acceptance to millions of merchants—and the corresponding technology and staffing investments—was outside their core competencies.

At the same time, the two vying bankcard brands were building state-of-the-art communications centers to support electronic authorization, clearing and settlement of credit card payments. I toured one; it had the feel of a NASA mission control center (which meant something at the time).

That the networks could connect merchants and FIs across the country and authorize transactions in seconds was revolutionary. In 2022, Visa, alone, reported it processed 192.5 billion transactions valued at $14.1 trillion. The top 10 acquirers, according to the website Statista, handled nearly 137 billion credit and debit card payments in 2022.

Fraudsters were quick to jump on opportunities they saw, requiring the brands and FIs to implement sophisticated technologies and processes to curb fraud. Subsequently, an entire cottage industry coalesced around card fraud detection and prevention.

Compressing clearing times, fighting fraud

In the industry's earliest days, card information was captured using a knuckle buster, a clunky machine that enabled merchants to imprint carbon paper slips with information such as card number and merchant ID. Merchants gave a copy to the customer, kept a copy for themselves, and bundled up additional copies for pickup by local bank employees to begin the clearing process, which could take weeks.

None of this could occur, however, until the merchant determined the number on the card was not in the various bulletins (booklets printed on newsprint and distributed weekly by the card brands) listing cards that were lost, stolen or over limit. (Eventually, the two card brands combined their bulletins.) Numbers were listed sequentially, and when a card number was not listed, the clerk would write on the charge slip the page number where it did not appear. Large-dollar purchases usually required phone calls to card-issuing banks.

With time, credit cards were affixed with magnetic (mag) stripes containing encoded information, such as card number and issuing bank, ushering in electronic authorization. With the 21st century came EMV, which further enhanced card security.

Incentives drive terminalization

As more bankcards were issued and more retailers embraced card acceptance, fraud escalated, creating a need for better screening technologies. And a small army of device manufacturers and authorization services emerged to keep pace with demand. Devices were designed to read information from mag stripes and route that information through authorization and clearing processes.

Verifone built the first electronic credit card terminal, the Zon Jr. It can still be found at merchant locales today, as can manual card imprinters (knuckle busters), although neither complies with EMV or other modern security requirements. Verifone and other manufacturers found the fastest way to get more terminals at merchant checkouts was to tap ISOs that were beginning to work with acquirers.

The earliest terminals were rudimentary. After all, the only thing needed was confirmation that a card was not lost or stolen, and the cardholder had sufficient credit to cover a purchase. When that was the case, a green light flashed on the terminal; if not, a red light flashed. More sophisticated terminals followed in response to merchant requirements and efforts to contain fraud.

Interchange flashpoint

All of this innovation and network capacity came with a cost. Interchange was the basic fee paid to card issuers primarily to cover the risk should the cardholder renege. But it has had other uses, as well.

Initially, interchange was set low to encourage merchant acceptance of electronic capture, and there were just a handful of interchange rates based on merchant category and perceived risk. Even as recently as the early 2000s, the card brands would lower interchange to spur greater adoption among certain categories of merchants.

It was around the turn of the century that interchange tables grew longer and more complex, and this became a flashpoint for merchants. Rates were not only set according to the type of merchant accepting the card, but also by type of card used. Plain cards are and were the least expensive, high-end rewards cards the most expensive.

Merchants became accustomed to battling with Mastercard and Visa. In 1996, 5 million retailers, led by Walmart, filed a lawsuit against Visa and Mastercard alleging, among other things, that the two card brands violated the Sherman Act (a federal antitrust law) with their "honor all cards" rules. These rules held that a merchant accepting Visa credit cards, for example, had to accept all Visa-branded cards, including debit cards.

That litigation ended in an out-of-court settlement in 2004, at a cost of $3 billion to Visa and Mastercard, and elimination of the honor-all-cards rule. (This was the first of several lawsuits lodged by merchants against Mastercard and Visa.)

The rise of debit cards

Debit cards took off in the early 1980s as FIs sought to move check-cashing customers to ATMs. (Before that, consumers needing greenbacks went to banks or local merchants and cashed personal checks.)

It didn't take long before several innovative banks, and the regional ATM networks they eventually set up, began experimenting with debit card acceptance at merchant checkouts. By the early 1990s, Visa and Mastercard had built their own debit networks, Interlink and Maestro, respectively.

While the same FIs that owned the card brands also owned the ATM networks, control of those assets fell to different functional areas. Credit card executives wanted merchants to use Mastercard and Visa to clear debit cards. And because credit cards were a more profitable product line for FIs than ATMs, these executives prevailed.

Other downsides of using the ATM networks for POS debit card payments included the need for PIN pads for authorization and separate contracts with ATM networks. POS debit took off with the Great Recession. In fact, credit card usage fell for the first time in 2010, and debit cards became Americans' first choice in non-cash payment methods, according to the Federal Reserve.

Congress takes notice

Credit and debit card acquiring remained an issue primarily between merchants, acquirers and the card brands until 2010 when a group of retailers convinced Senator Richard Durbin, D-Ill., to add an amendment to the Dodd-Frank banking reform act. That led to the regulation of debit card fees, which at the time ran about 2 percent. Spurred by the Durbin Amendment, the Fed capped debit card interchange at 22 cents plus 0.05 percent of the transaction amount, but this cap applies only to the largest issuers of debit cards (assets exceeding $10 billion). Thousands of community banks and credit unions are exempt from the cap. The Fed reported that in 2021, debit interchange at covered FIs was 23 cents; the average for exempt FIs was 52 cents.

While the intent of the Durbin Amendment was to create savings beneficial to merchants and consumers, numerous studies suggest otherwise. Banks generally offset losses in interchange revenue by raising other consumer account fees and eliminating free checking for all but their wealthiest depositors. The Federal Reserve Bank of Richmond found fewer than 2 percent of merchants passed along savings on interchange to consumers; 20 percent increased prices post Durbin.

The Durbin Amendment also mandated merchant choice in debit card routing and made clear that the card brands cannot prevent merchants from steering customers to cheaper payment methods, like cash.

Merchant choice is the centerpiece of Sen. Durbin's proposed Credit Card Competition Act, and customer steering is gaining, with agents selling cash discounting, surcharging or some other dual pricing methods. Look for more on these and other trends in future installments of this series. end of article

Patti Murphy, senior editor at the Green Sheet, has been following and writing about payments for 40 years. She has been working with Green Sheet for 25 years. Patti is also co-host of the Merchant Sales Podcast.

The Green Sheet Inc. is now a proud affiliate of Bankcard Life, a premier community that provides industry-leading training and resources for payment professionals. Click here for more information.

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