Payments PIN Network Mistakes That Cost Financial Institutions Big Bucks

In the ever-changing world of payments, the gritty details in vendor PIN network contracts matter – a lot. And ignoring these details or getting agreements wrong can cost financial institutions as much as six or even seven figures over the life of a contract.

In just the last year:

• Two networks decided to compete with Visa and Mastercard and begin performing dual message transactions, enabling them to earn PIN interchange and not SIG interchange. This new transaction type can start to cannibalize their signature volume, which has a trickle-down effect in that if there is a branding agreement in place with volume commitments with Mastercard or Visa, rebates will be impacted and penalties could be incurred.
• Virtually all networks eliminated the $50 threshold on PIN-less transactions.
• eCommerce transactions started being processed on single message (PIN) networks.

The net result? Collectively, these three changes are significantly altering the mix between signature and PIN-based transactions. The mix was 80/20 only three years ago. Now, many card issuers are seeing 50% PIN, 50% sig. Assuming an institution’s sig interchange income is roughly double that of its PIN interchange income, this results in a revenue reduction of 10% annually.

Why? Here are the three mistakes financial institutions make with their PIN networks that can lead to that 10% reduction.

Mistake #1 – Making card processor and PIN network decisions together with one vendor

This is the number one mistake made by FIs, and we see it happen over and over. The processors make it sound so simple and attractive – one contract, one provider. But bankers, PIN network and card processor contract negotiations should never be coupled. Sure, it is very easy to combine them; it’s one less decision to make. But in the perpetual race to the bottom on transaction pricing and interchange, the goal must be to get the best combination of processing and interchange costs, and coupling these decisions often works against that goal.

A practical example:

• A bank or credit union is paying an all-in processing cost of $.02 per transaction. The institution is also earning $.24 in interchange fees per transaction – the rough average based on public interchange tables.
• The institution could accept a vendor offer to reduce the processing fee to $.01, which sounds like a 50% reduction, except that the institution may be signing up for a network that pays only $0.22 for interchange. For that $.01 gained in processing, the institution lost $.02 in interchange on every transaction.
• I would suggest that $.02 is on the low end because most networks have preferred rate tables that pay more than the publicly stated rate, and issuers that are properly managing their PIN networks are earning between $0.25 and $0.29/transaction.

To further illustrate, a Federal Reserve study published in June 2018 compares rates from 2014 to 2017. More than 75% of PIN networks have seen reductions or fluctuations to their average interchange rate since 2014. However, there is still a $0.10 differential between the highest and lowest, or a $.16 differential between Interlink & STAR – a difference that is worth more than any reduction to transaction processing costs.

SO WHAT?

Card processor and PIN network contracts must be negotiated as two different contracts. Banks and credit unions looking for the best possible deal should:

• Negotiate their card processor contract with competitive market pricing that has nothing to do with the institution’s commitment to the processor-owned PIN network.
• Negotiate the PIN network agreement with incentives commensurate with the institution’s value (transaction volume) to the network.
• Watch for hidden fees that in many cases the institution doesn’t realize it is paying. Many PIN networks have added a penalty fee for any transaction that is processed as Interlink, PAVD or Maestro when the institution belongs to their preferred interchange tables. This fee is often collected via interchange settlement and buried in reporting that the institution may never see.
• Avoid, whenever possible, signing for more than three years with a PIN network. Pricing will continue to commoditize, and no institution wants to wait five years to see new pricing.

Mistake #2 – Picking a network based solely on published interchange rates

If this were just an interchange discussion, then the Fed’s chart would provide a quick answer as to the right partner. But, the rates in the chart are an average. No two financial institutions are alike, and a bank or credit union’s ability to earn the average published rate (or greater) is dependent on its cardholder mix, where it uses their cards, and where the institution is geographically located.

Networks are not known for guaranteeing the interchange rate in the Fed’s data, and financial institutions should not make decisions based only on this data.

SO WHAT?

Before a financial institution chooses a PIN network provider, it should perform a complete evaluation that includes analyzing cardholder spend and then negotiate appropriate fees and incentives with the selected provider.

Mistake #3 – Not finding a compatible partner

Is the institution’s “back of the card” compatible with its “front of the card?” At the end of the day, any network will work with any processor and with any front of the card brand. However, a bank or credit union needs to understand the best possible combinations for the institution and its revenue.

What I am specifically referencing is this:

• Which back of the card networks financially pair well with the institution’s front of the card network? Some PIN networks are known to take more of the signature volume than others.
• What additional transaction types does the secondary network allow – PIN-less, eCommerce, dual message, etc.?
• What percentage of the institution’s PIN spend is done at grocery? Institutions that have more than 50% of their PIN spend happening at Walmart or Kroger, which pay rock bottom interchange fees, have my sympathies.
• Where is the institution geographically located? The region typically makes a difference in the PIN/sig transaction mix.

SO WHAT?

All of these factors are critical, especially when selecting a secondary PIN network. Financial institutions want to earn the average rate of interchange (or higher) published in the Fed data.

Networks are aggressively trying to steal market share, much more so than even two years ago. And this activity is not going to stop, because their movement of transactions to PIN is working. Networks have managed to shift at least 10% volume from signature to PIN for many financial institutions, which is good for the networks but very bad for banks and credit unions. All PIN networks used to be equal, but with the introduction of new transaction types in the last year, this is no longer true. Financial institutions need to ensure they are properly rewarded and protected in their decisions. Banks and credit unions armed with this knowledge can avoid these three mistakes and maximize their debit income.