Durbin Exemption Proves a Real Edge for Small Banks

The new year is a good time to reflect. I remember the run-up to Dodd-Frank when community banks joined hands with megabanks in a united front against the gathering threat of a heavy-handed regulatory response to the recession.

Back then, while awaiting my turn on stage at a bank conference, I watched the chairman of a national banking association whip a crowd of bank CEOs into a frenzy, telling them the Durbin amendment — despite its exemption of smaller debit card issuers from its rate cap — would ultimately devastate all banks' debit card fee income, regardless of size.

I disagreed and made the potentially career-limiting decision to express that dissent during my presentation. I explained that, at a minimum, Durbin would create a two- to three-year competitive advantage for smaller issuers, an advantage upon which community banks should capitalize fully. The chairman confronted me afterward and told me in no uncertain terms that my speech threatened to divide the ranks at a time when unity was essential. So, as any good Southern boy would, I politely apologized for being honest.

Well, good news: We are officially more than one year into Debit 2.0, the post-Durbin era brought to us by way of the Federal Reserve's Regulation II, and smaller debit card issuers' fee income remains largely intact.

Oliver Wyman's 2012 Debit Issuer Study, commissioned by Pulse, reports that debit card growth remains robust. The average consumer debit cardholder spent $8,326 on a debit card in 2011, up from $7,781 in 2010. Active debit users averaged 18.3 debit purchases per month, up from 16.3 the year prior. For 2012, exempt debit issuers (under $10 billion in assets)are expected to see 14% growth in PIN debit transactions, 13% for signature.

Studies by the Federal Reserve, Wyman and most recently the Government Accountability Office indicate that exempt issuers have experienced little if any compression in their signature debit interchange rates and virtually no compression in their PIN rates. According to Wyman, exempt issuers' gross margin per debit transaction is now more than double that of regulated institutions.

Recently there have been anecdotal reports of exempt issuers experiencing debit interchange rate declines of 6% to 8%. The good news is that even if those declines reach 10%, the compression is more than offset by current and projected growth in total transaction and dollar volumes per debit card.

Even better news for smaller issuers is the attractive economics of business debit cards. Exempt issuers still enjoy interchange as a percentage of the transaction amount, while regulated issuers labor under a fixed cap that does not float with the amount of the transaction. This means big issuers suffer most on high-dollar transactions such as those common to business debit cards.

Before Reg II, business debit card transactions commanded a much higher interchange rate than consumer debit transactions. According to Wyman, "the revenue per business debit transaction was notably higher … averaging $2.10 (versus $0.52 for consumer signature debit)."

Under the interchange cap, however, business debit's profit margin for large issuers dropped drastically to 26 cents per transaction. For many regulated issuers, business debit is now unprofitable, as the average cost of a business debit transaction exceeds the average revenue. The result is tactical retrenchment from business debit portfolios by large issuers.

As such, exempt issuers have an opportunity to capitalize on the most profitable segment of debit card volume at precisely the time Reg II has made it untenable for regulated issuers.