Worries Over A 'Race To Bottom' In Debit

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DES MOINES, Iowa-As credit unions make PIN network choices to comply with the new debit interchange rules, they need to be careful they don't get caught in the "race to the bottom."

That is the scenario several analysts worry could develop if some networks-despite honoring the two-tiered system-decide to cut debit interchange rates to attract more merchant volume. That move could also lead to networks being overloaded with transactions, which could affect member service.

TJ Rija, CEO of PayFusion, is concerned that credit unions may not be aware of the potential issues with choosing PIN networks. Under the new interchange guidelines, financial institutions are expected to have at least two qualified, unaffiliated networks on their debit cards by April 1, 2012. Merchant routing discretion begins this Oct. 1.

"The $10-billion exemption may have created a false sense of security among credit unions that nothing is going to happen to them, that the two-tiered system is in place and they don't have to worry," Rija told Credit Union Journal. "With the change that goes into effect Oct. 1 (merchants having routing choice), if you are in multiple PIN networks you could start to see some financial impact."

The issue, according to Rija, is the business model for PIN networks has been "turned upside down. Originally the model was focused around the card issuer, with the networks working to get them their best prices. In the new world it's all about the merchant. So networks could begin to lower prices to attract more merchant business."

Where CUs stand to lose the most, said Rija, is when they have more than one PIN network on their card. The merchant can, and will likely choose to, route to the network that pays the least.

"Previously, a credit union could direct the merchant to send a transaction down the network that would make them the most money," reminded Rija, who has authored the "Race to the Bottom" white paper on this topic. "Sending transactions down the lowest-cost route for the merchant could lead to lower average interchange, as well as additional expense or fees for the issuer when transactions do not follow their preferred network path."

What To Do Now

The steps credit unions need to take now, analysts agreed, are to gain a strong understanding of the direction in which their network business partners are heading, including network fee structures and interchange projections, gauging network infrastructure and capacity, and assessing their networks' long-term plans.

Jeff Russell, senior advisor for The Members Group in Des Moines, Iowa, believes such a race to the bottom could occur, and said CUs should choose the network that provides the appropriate coverage and determine if the CU feels confident that the partnership will take the credit union through the next 18 to 24 months of change. "Then you have to make decisions on duration of the contract-there are pros and cons. You could lock in a decent price today to hedge against changes, or you can ride the market and go shorter and see what happens."

While Russell believes credit unions need to be thoughtful with their decisions, they don't have a great deal of time. Russell is worried that some will wait too long and could possibly get caught in a backlog of requests to be routed through networks. "I believe credit unions can't wait beyond the next 45 days."

Tom Gandre, EVP of product management and technology for the St. Petersburg, Fla.-based PSCU, said one thing that is certainly going away for good is the old debit card that "looked like a Winnebago," with all the network affiliations on the back. "Some of those relationships did not drive nor optimize credit union returns. Now is a great time to look at the relationships on the back of your card and make sure you are participating with the right brands that drive the right value and set of economics for your business."

Eric Porter, EVP of business development and marketing for Co-Op Financial Services in Rancho Cucamonga, Calif., said credit unions need to be careful in choosing network pricing now. "The PIN networks are negotiating heavily with credit unions to sign them up, and they are throwing out a lot of different pricing."

One Suggested Strategy

CU24, Tallahassee, Fla., recommends that credit unions, when possible, choose only one unaffiliated PIN network and one unaffiliated signature network. "This puts you in compliance (two unaffiliated networks) and provides the merchant with only one routing option for signature and one for PIN, which could keep you away from the spiraling downward pressure on interchange," said Stu Bloom, a payments industry consultant who spoke at a recent CU24 webinar.

The Clearwater, Fla.-based CSCU recommends the same approach, reported Bill Lehman, VP of portfolio consulting. "Credit unions need to evaluate their network relationships and pick one PIN network that is best for their footprint and membership, and is national scope. If you are putting that one (PIN) bug on your card, you take away the merchants' ability to go to a lower-cost network and make them go the route you have selected."

Gandre does not buy into the concept that PIN networks will lower interchange rates in a fight for volume. "They are commercial entities that compete on an everyday basis for business through the value they provide. Logic would dictate that if someone is trying to make a large play in routing and drive the economics down toward the bottom, why wouldn't people leave the network when their contracts are up?"

Mark Atchison, VP of business development for the Brookfield, Wis.-based Fiserv is not ready to make any call on network plans. "It is simply too early to tell."

If networks do in fact vie for more business, another problem that could occur, according to Rija, is that networks may not be able to accurately forecast transaction volume. Processing performance could suffer, leading to time-outs that may result in higher-risk stand-in processing or failed transactions. "In the past networks could project volume based on how many banks and credit unions they had under contract and how many cardholders were out there. They could look at that data and seasonal and cyclical trends and determine capacity requirements. In this new world all the networks are having to try to forecast based on what merchant volume they think is going to come their way-which is much harder."

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