Just as dams and canals alter water flows, bank mergers and technology trends are changing the course of credit card transactions.

As banks extend their scope through mergers, and as the economics of transaction processing forces more and more of that business into fewer and fewer hands, payments are increasingly bypassing the MasterCard and Visa networks.

Taken to an extreme, the trend raises doubts about the clearing and settlement roles played by the two card associations and the income they derive from that activity.

The phenomenon is similar to checks that clear within a single institution that holds both the payer's and payee's accounts - "on-us" items.

Banks that are strong in both issuing cards and acquiring transactions from merchants, and companies like First Data Corp. that provide services to both issuers and acquirers, are capable of closing MasterCard and Visa out of their loops.

This may not be a total disaster for the bank-owned associations. It affects a fraction of their revenues and has not yet hindered their ability to perform core functions. But it may bring about long-term changes in the associations' relationships with financial institutions and third-party processors.

"On-us transactions are very important because they are inherently profitable to the processor, both in terms of information and in terms of the sheer processing costs that are involved," said Bill Burnham, senior research analyst at Piper Jaffray Inc., Minneapolis. "The more information you have, the more leverage you have in terms of the ability to turn that information into extra revenue."

Mr. Burnham called attention to the shifting balance of power in an August report on First Data. The Hackensack, N.J.-based processor almost singlehandedly raised the industry's consciousness about on-us consequences-and sparked a continuing industry debate-by acquiring two of the biggest merchant-processing companies since 1995.

The acquisitions of First Financial Management Corp. and Card Establishment Services made First Data, already No. 1 in card account processing, also No. 1 in handling merchants' card receipts.

That raised the specter of an independent "closed loop," with transactions clearing within First Data and remaining outside the MasterCard-Visa sphere of influence.

First Data has sought to dispel any power-grabbing suspicions by turning much of its merchant business over to merchant bank alliances, joint ventures it has formed with about a dozen of its client banks. But the closed-loop threat is still at least theoretically real to the card associations.

The leading processor does not disclose how much of the 2.3 billion transactions it processes annually are on-us, but industry experts say most go through the merchant bank alliances. Mr. Burnham said as much as 15% of U.S. credit card transactions are on-us.

First Data has "the single largest information flow of any major electronic payment processor in the world," Mr. Burnham said, "and that kind of information is priceless."

"In the future it will be one of the key components of their overall business, and one of the most important businesses," he added.

In 1995, MasterCard and Visa responded with new regulations for on-us transactions. Processors of on-us transactions had to pay a fee and send along certain information about the transaction.

The card associations "get the money and the information even though there is no technical reason why they should," Mr. Burnham said. "The logical question in everyone's head is why should (the processors) continue to do this."

MasterCard and Visa offered only general comments about how they viewed the on-us trend.

"I would guess 15% to 20% of transactions in the U.S. don't go through our system," said David Nordemann, Visa U.S.A. executive vice president for risk management. "We felt it was time to look at the whole situation and we decided that mandatory routing was not the way to go."

R. Douglas Rozman, a MasterCard International spokesman, said it had "noticed the growth of on-us transactions partly due to recent merchant alliance agreements between major processors and leading issuers." MasterCard is "monitoring the situation and will take appropriate action if deemed necessary."

Acquiring-side expert Paul Martaus, president of Martaus and Associates, Clearwater, Fla., said 50% of Visa's revenues come from transaction processing. Visa does not disclose its income, but MasterCard reported $946 million of total revenue in 1996, which came from both service fees and member assessments.

William J. Westervelt Jr., principal of First Annapolis Consulting, Annapolis, Md., estimated that gross revenues for the merchant-acquiring business totaled $10 billion last year. Acquirers received $2 billion, the associations $500 million, and card issuers the rest in the form of interchange fees.

Mr. Martaus said while Visa and MasterCard no longer require a technological link to third-party processors, processors "have to provide Visa on a daily basis a copy of all the transactions that flowed through the system to ensure the revenue flow."

Meanwhile, Mr. Martaus added, "The big on-us players are saying that they want to eliminate the middle man.

"The question is, if I am a merchant linked to a First Data system, and I want to authorize a transaction against an account that is on the First Data system, why do I have to pay the transaction fee to Visa?"

BA Merchant Services said its on-us transactions are growing dramatically, at 40% to 50% a year. The company's affiliate, Bank of America, is the second-largest U.S. issuer of debit cards and is in the credit card Top 10.

James M. Aviles, senior vice president of BA Merchant Services, said the unit does close to 80 million on-us transactions a year, worth $1.6 billion.

"The result, from the merchant standpoint, is a reduction of about 10% of the transaction processing fee," Mr. Aviles said.

Visa and MasterCard were created when the industry was much more fragmented, Mr. Aviles pointed out. The clearing infrastructure will come into play less frequently as banking organizations transcend old geographical boundaries and merchant processing becomes increasingly consolidated.

"I think you will see ... a huge pool of the Visa and MasterCard volume going through a highly concentrated number of financial institutions," Mr. Aviles said. "Especially as banks continue to acquire across regions, becoming more national in scope, the financial institutions are going to have to take a step back and reassess the value of their brands."

"Visa and MasterCard have enjoyed a very privileged position and I think what you are going to see is a concentration of on-us transactions in just a few major providers," Mr. Burnham said. That will "shift the balance of power back into the hands of the end processor."

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