Dadburn it, GonzoBankers!! What the heck just happened to us? It seems not a few months ago I was reporting major changes to POS interchange that was going to refill the war chests, and now we have been Durbinated. I’m sure Dick was just trying to get to the root of the mortgage-related financial crisis. All those people paying their CRA-Mandated Option ARMs with their debit cards. That’s why Countrywide and WAMU went belly-up – high interchange rates. Actually, the timing of Wal-Mart’s pledge the night before the Senate vote to invest $20 million in that bastion of political ethics, Illinois, is more than a bit coincidental about how this bill finally got passed. It must be a slap in the face to Wal-Mart’s lawyers and their inability to negotiate better network deals that Wal-Mart had to resort to Durbin politicking. It also speaks to the lack of free-market support from America’s merchants. They can’t figure out a way to conduct secure payments any cheaper, so they maneuver in Washington for price controls.
Enough ranting about the long arm of the law. What’s done is done. Now let’s dig into what the Durbin Amendment could mean for your bank. While it’s the Fed’s responsibility to come up with the rules in the coming months, the Dodd-Frank Act’s framework provides for some interesting implications.
1) INTERCHANGE FEE PRICE CONTROLS
Sec 920.a.3 requires the Fed to set interchange rates that are proportional to the cost. Using a truck driving analogy, will the Fed consider just fuel and insurance, or will it also look at oil changes, tire replacement, tolls, brake pads, engine depreciation, inspections, licenses, driver training, etc.?
Fortunately there is a Sec 920.a.6 that provides an exemption for small issuers from these price controls. Issuers with assets less than $10B are not subject to these Fed price control rules. However, the actual implementation and management of this exemption requires such overhead (End-of-quarter assets? Holding company assets?) that it is probably worthless. Of course it helped sell the bill to that caucus that is looking out for us “little guys,” but don’t count on earning more than Wells Fargo for the same transaction.
You would think a tiered interchange schedule by issuer BIN would almost be a programming no-brainer. Especially when you consider the complex merchant categories and tier structures the networks have established. But the noise I am hearing is that “it can’t be done.” Sounds like a typical I.T. response, eh?
This is one area where being a member of one of the networks that is not heavily dependent on large issuers could prove beneficial. If Network A or Network N have 90% of their switch traffic coming from issuers less than $10B, they may be more inclined to cater to this base and figure out a way to offer higher interchange for small issuers and thereby attract more business. For Network I and Network M that have 98% of their activity coming from issuers greater than $10B, they don’t get a lot of payback for creating a two-tiered interchange schedule.
Over the next few months, as the Feds begin to develop rules we hope they will solicit comments. To protect as much income stream as possible, financial institutions need to identify someone within their organizations to respond to these requests, and small issuers should be as vocal as ever.
2) FRAUD INTERCHANGE
The law does allow the Fed to adjust interchange for issuers who incur additional overhead by implementing “cost-effective fraud prevention technology.” U.S. Issuers have stayed away from chip & PIN cards because it drives more transactions to PIN and away from richer-margin signature-based transactions. But if large issuers can get a lift on PIN interchange with chip & PIN (assuming the Fed’s deem chip & PIN “cost-effective fraud prevention technology”), banks can expect that this technology could have a solid business case.
3) LIMITATIONS ON NETWORKS
A little known paragraph (Sec 902.b.1) was slipped into the final version of the law. Somehow I feel like Wal-Mart may have “helped” with the drafting here. It’s damn difficult for me to see how network membership and priority routing has anything to do with Consumer Financial Protection or the economic meltdown. This paragraph says that issuers and networks cannot restrict the number of networks to either (i) just one network and (ii) two or more owned by the same company. Thank you, Mr. Durbin, all future banking crises will certainly be avoided now.
Since this is in Sec 902.b and the small issuer exemption is in Sec 902.a, we should interpret this as even small issuers cannot be exclusive with a single network. Whether this means that existing bank and credit union exclusive contracts will need to be broken is unknown. I can’t imagine the Fed would usurp current contract law, but who would have thought you could be fined for not having health insurance? Maybe we should all sign 30 year exclusivity agreements?
The POS networks have really been pushing exclusivity. A lot is up in the air about what is exclusivity. Is it possible to add a Network P that only works in one grocery store chain and satisfy the law’s requirement? This would be great for issuers that don’t have a presence where that grocery store is located. Heck, I might even start CroalNet that works only at my dad’s woodworking shop. Y’all come on and join me.
Overall, I don’t see a long life for traditional rewards programs. If a bank has a debit rewards program already and doesn’t think it can leave it, another option is to charge a monthly fee. This will let the customers opt-out themselves instead of getting kicked out by the bank. Blame it on Congress when the cardholders (and the vendor) howl. Regardless, banks should not let that current rewards contract auto-renew if it is due before the Feds make up their rules. It’s important to maintain flexibility right now.
The interchange banks earn on PIN debit is now coming very close to the margins earned on signature debit, especially since Visa and MasterCard went public and have jacked up their fees. Higher fraud costs have also helped to contribute to the attractiveness of PIN for the issuer. If sig debit fees get slashed, does it even make sense to have a traditional debit rewards program? As the chart below shows, there is an interchange benefit for high dollar signature debit transactions. One strategy is to have a debit rewards program but only pay out when the transaction amount exceeds a threshold. Grocery transactions cap out at $40, and fuel transactions are limited by the amount one can spend filling a tank of gas.
Retail is where banks can really make a case for paying rewards for signature transactions over a certain dollar amount. From this chart, which is based on interchange schedules from a popular POS network and a popular signature network, you can see the point at which signature really starts to outpace PIN is about $100. That’s a nice easy round number for your customers to remember. Tell them girls to throw more shoes in the buggy and think about rewards for sig transactions over $100.
Interchange for Retail Transactions by Purchase Amount
Rethinking debit rewards is just one of many strategies banks should be considering in a post-Durbin world. Since this is now a full-fledged war between issuers and merchants, let’s go out with a blaze of glory. Break out the paintball mask and think about spraying the merchant with some Benjamin Moore lavender décor. Here are two moves we may see banks use as they try to counterstrike Durbin:
There are a lot of pieces on the chess board to understand as we move into a post-Durbin world, and these moves will be important for protecting our payments revenue and keeping what’s left of the free market as fair as possible. Stay informed. Be loud when the Fed asks for comment and happy hunting.
Cornerstone Advisors’ Point of Sale Strategic Execution (POSSE) offering can help banks optimize their strategies for card payments in a Post-Durbin world. Our proprietary analytic tools match opportunity in the cardholder base with pricing in the network world. Being armed with this information is a first step toward maximizing future payments revenue.
Contact us today to learn more about the Cornerstone POSSE.