Debit card issuers' rewards programs are already being rewritten — and in some cases eliminated — in advance of the Federal Reserve's new interchange rules.
An expected decline in interchange revenue, the primary source of funding for the programs, is forcing the banks' hands, payments executives and analysts say. Specific customer segments may find themselves cut off from certain debit rewards — assuming the rewards programs aren't flat-out eliminated.
JPMorgan Chase & Co. became the first to disclose its plans when an executive said at an analysts conference last week it would stop issuing debit rewards cards in February. A Wells Fargo & Co. executive said in an interview Tuesday that it is evaluating changes in its rewards programs.
Though many payments experts were unsurprised by JPMorgan Chase's decision, they said the timing was somewhat unexpected, since most banking companies have said they would wait for the Fed to issue its proposed interchange guidelines before announcing any changes in rewards programs or checking products.
"I think this is the first step of what most in the industry see as inevitable — and that is the demise of rewards on debit cards," said Bill McCracken, the chief executive officer of Synergistics Research Corp., a market research and consulting firm in Atlanta.
Issuers' debit portfolios were already under pressure from the overdraft rules that took effect in July, requiring banks to obtain customer consent before charging fees to cover certain overdrafts. That, combined with the debit interchange provisions of the Dodd-Frank Act signed into law in July, has issuers considering adding account fees, raising minimum balance requirements, reducing rewards and other measures to recoup revenue losses.
Ed Kadletz, an executive vice president and head of debit and prepaid cards at Wells Fargo, said that rewards, as well as investments in contactless card technology and instant-card-issue services, are offered based on projected revenue.
"We do that with a certain return on investment in mind funded by interchange," he said. "If that interchange model changes, you've got to go back and reevaluate those investment decisions and figure out if there are modifications that can be made."
The San Francisco banking company has made no formal decision about changes it might make in its debit card products and its rewards programs.
"We're still in the evaluation phase," Kadletz said, "but certainly it's going to be impacted by whatever the Fed determines on interchange."
Wells, as do many issuers, includes some merchant-funded offers in its rewards programs. Kadletz said he sees the potential to do additional merchant-funded rewards as a result of potential interchange losses.
Steven Jacowitz, a managing director in the payments consulting firm Auriemma Consulting Group in New York, said, "Every bank is going to handle it different[ly], and every bank is going to put a value on a particular customer and determine what types of fees are appropriate for that customer."
JPMorgan Chase has stopped paying bonuses to bank employees to issue debit cards, Charles Scharf, the chief executive of retail financial services at the New York banking company, told the BancAnalysts Association of Boston Conference on Thursday.
Because of a reduction in debit interchange, some people are going to be less profitable customers, Scharf said. "Getting someone to be an active debit card issuer was a very important driver of profitability," he said.
JPMorgan Chase spokesman Tom Kelly said the company is still evaluating how it will address existing debit rewards customers.
Its decision may not immediately influence other banks' decision-making, but it is "certainly easier to follow someone else's … lead," said Duncan Douglass, a partner who focuses on payments issues for the Alston & Bird LLP law firm in Atlanta.
Depending on the Fed's guidance, most card issuers are likely to act in lockstep regarding rewards programs, Douglass said. "It's unlikely to be just a couple of banks eliminating their debit rewards programs and everyone else" continuing to offer them, he said.
"There will be safety in numbers at that point," Douglass added.
An amendment in the Dodd-Frank Act gives the Fed the duty of establishing interchange rates that are "reasonable and proportional" to the costs that issuers incur on transactions. Financial institutions with less than $10 billion of assets and prepaid cards are exempt from the provision.
Depending on what the Fed does, the provision could result in the loss of up to $9.1 billion in yearly revenue for issuers, according to a study released last week by CardHub.com, a website that tracks card products.
The Fed is expected to issue proposed interchange guidelines by yearend or early in 2011.
Though many issuers will cut debit rewards across the board, others may offer the programs to "premium customers" who maintain high balance levels or use multiple products, said Zilvinas Bareisis, a senior analyst in London for the Celent research firm.
He also said he expects a "massive uptake" in the use of merchant-funded rewards programs as a way for banks to continue offering programs without having to pay their full cost.
About 40% of all debit card holders use a rewards program, according to research from Synergistics. Banks that drop their programs risk customer backlash, Synergistics' McCracken said.
Capital One Financial Corp., which offers a Rewards Checking account, has no plan to change its program at this time, said a spokeswoman for the McLean, Va., banking company. Bank of America Corp. declined to discuss changes it may make in its programs as a result of debit interchange regulations.
Until the Fed releases its draft rules, "it is premature to discuss specific implications [for] debit card rewards programs," the company said.
