By Patti Murphy
In the wake of a U.S. District Court judge's ruling that the Federal Reserve Board erred when it capped debit card interchange as instructed by the Durbin Amendment to the 2010 Dodd-Frank Act, it's worth noting that debit cards remain America's preferred electronic payment method.
The latest proof comes from a pair of surveys: one queried consumers, the other debit card issuers.
According to the Houston-based Southwestern Automated Clearing House Association (SWACHA), 21 percent of a group of Texans it recently surveyed said they used debit cards daily. Just 14 percent are daily credit card users, SWACHA said.
Meanwhile, a survey of debit card issuers, conducted by Pulse, the debit network owned by Discover Financial Services, revealed that card issuers continue to grow their businesses despite new federal rules that limit the amount of interchange they can collect.
"Even in the face of significant regulatory challenges, issuers managed to grow their debit volumes in 2012 and expect further growth this year," said Steve Sievert, Pulse's Executive Vice President for Marketing and Communications. The Fed's debit card interchange rules (contained in Regulation II) apply to card issuers with at least $10 billion in assets. The regulation caps at 21-cents the basic allowable interchange a merchant can be assessed for clearing a debit card transaction. (There's a markup available for some to cover fraud losses.)
Additional provisions include a requirement that merchants be given choices about which debit networks are used to clear transactions. Financial institutions with less than $10 billion in assets are exempt from interchange caps. The Fed's data indicates interchange revenues have taken a nose dive as a result of Reg II: the $15.4 billion in debit interchange collected by all issuers in 2012 was down 24.3 percent from 2011 collections, according to a report the Fed released in March 2013.
Nearly half of that amount ($7.4 billion) was paid to card issuers that are exempt from the interchange cap, the Fed said.
Merchants balked when Reg II was adopted. A group sued the Fed arguing that the rate ceiling wasn't low enough and that the network routing rules weren't sufficiently flexible. Judge Richard J. Leon of the U.S. District Court for the District of Columbia agreed.
On July 31 he ordered the Fed to change the rules by lowering allowable interchange further and allowing merchants greater network flexibility. (For more details, see "Back to square one: Court smacks Fed over debit interchange rules" in the News section of this issue of The Green Sheet.)
It's an unusual situation for the Fed. I've been reporting on and writing about the Fed's role in the U.S. payments system for several decades, and I can't remember any other instance when the Fed's arguments in a legal squabble were so soundly rejected. "In short, the Board's interpretation [of the Durbin Amendment] is utterly indefensible," Judge Leon wrote in his 58-page decision.
Over the years, the Fed has gone to great lengths to forestall legal challenges to its rulemaking - issuing and reissuing requests for comments to ensure all affected parties' concerns were given ample consideration.
The Fed didn't have that luxury with the Durbin Amendment: statutorily it was given less than a year to craft a set of rules that would satisfy all parties involved. The result was a plan nobody liked. Debit card issuing banks objected that the cap was way too low; merchants insisted the cap should be set even lower.
Judge Leon's ruling won't be the last word on interchange caps. Most experts expect the Fed to appeal the ruling, and the appeals process will likely take years. So for now, at least, it's the new status quo: lower interchange for debit card payments among issuers of all sizes, although not necessarily reduced earnings opportunities on their debit card portfolios.
"Issuers are more tepid in their outlook for debit; they still expect the industry to grow, just not as rapidly as in the past," said Tony Hayes, a Partner who co-led the Pulse study at the research and consulting firm Oliver Wyman Group. The survey found issuers have experienced strong performance in key metrics.
Penetration increased to 77 percent, up from 76 percent in 2011, and the average active cardholder performed 19.4 debit card transactions per month last year compared with 18.3 the year before.
The result was that total annual-spend per active cardholder reached $8,753 in 2012 versus $8,326 in 2011.
The 2013 Debit Issuer Study also revealed that fraud losses are down for both signature- and PIN-authorized debit card payments. PIN debit, however, is eight times more secure than signature debit, Pulse said. It noted that fraud losses on PIN debit payments fell to $0.003 per transaction from $0.004 per transaction.
According to the Pulse survey, financial institutions are reacting to the new status quo for debit cards with "fundamental changes" to their debit programs, such as restructuring demand deposit account (DDA) products and revamping or eliminating rewards programs.
If the SWACHA survey is indicative of public sentiment, however, issuers might want to think twice before deep-sixing rewards programs. Among Texas consumers surveyed by SWACHA, 41 percent said debit card rewards/loyalty programs are very or somewhat important to them.
Credit card rewards are even more important: 69 percent of surveyed consumers said rewards/loyalty programs are very or somewhat important considerations for using a particular card.
"Financial institutions should realize that many consumers are continuing to reevaluate their credit and debit card options and are closely looking at rewards programs to help choose which card is right for them," said Dennis Simmons, President and Chief Executive Officer of SWACHA.
The association's data, gleaned from its 2013 Consumer Insights Survey, included additional data on consumer card habits.
For example, 46 percent of consumers surveyed said they pay off their credit card balances every month; another 20 percent said they pay off the balances most months.
That's a major shift in consumer behavior since the start of the Great Recession in 2008, and one that isn't apt to be reversed even with improvements in the overall economy.
This is part of the new status quo in card payments - a status quo that also places increased importance on new payment options, including prepaid cards and mobile payments.
Patti Murphy is Senior Editor of The Green Sheet and President of ProScribes Inc. She is also the founder of InsideMicrofinance.com. Email her at firstname.lastname@example.org.
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