Lower Debit Interchange Rates May Mean Higher ACH Debit Rates, Aite Says

With debit card interchange rates expected to go down next year, rates for automated clearing house debits could go up as financial institutions attempt to make up for lost revenue, new research suggests.

Competitors for years have been able to use the ACH system to tap into debit card issuers' checking accounts. PayPal Inc. thrives on it, and Tempo Payments Inc. uses ACH debits to promote so-called decoupled debit cards.

The ACH network "stands as a prime candidate for pricing reassessment," a report from Aite Group, "The New Order: How Interchange Regulation Will Change the U.S. Payment Industry," concludes.

Banks for years have groused about the "free ride" the ACH network has given to alternative payments providers. But as long as the institutions could generate hefty revenue from other sources — such as lending, overdraft fees and card interchange — tackling the issue was not a high priority, writes Gwenn Bezard, an Aite senior research director and the report's author.

Mike Grossman, Tempo's chief executive, said the ACH fees his company pays "are relatively low, all things considered."

Depending on the transaction volume, for a company tapping into a bank's checking accounts through ACH withdrawals, the per-transaction fee could be less than 1 cent, Grossman said. "We're higher" than that amount, he said, declining to specify pricing.

As mandated by the Durbin amendment in the Dodd-Frank Act, the Federal Reserve Board later this month could issue proposed payment card network guidelines for the setting of "reasonable and proportional" interchange rates. Many observers believe the Fed will propose sizable rate reductions, resulting in substantial declines in debit card issuer revenue. Aite said issuers can expect interchange revenue to drop by 40% as the rates become cost-based.

Javelin Strategy and Research estimates that the largest U.S. card issuers could lose more than $2 billion a year in debit card-related revenues from the combination of new regulations cutting into overdraft fees and pending debit-interchange regulation.

As Bezard said in his report, "Since the Durbin amendment limits interchange regulation only to transactions flowing over payment card networks, banks should face no regulatory obstacles to addressing ACH pricing. A number of banks also feel like the rising fraud issues associated with ACH transactions, and the liability carried by banks, should alone justify a review of the pricing model."

The Durbin amendment could have a considerable impact on the market. "A significant rise in ACH costs could literally put PayPal out of business," Bezard said. PayPal representatives were not immediately available to comment.

In an interview, Bezard conceded that banks will face challenges trying to increase ACH prices significantly. "We'll see strong efforts to raise the ACH fee. Will it be a lot? Probably not. But they will try to close the loophole," he said.

Indeed, the Fed will be very careful not to appear to be circumventing or "compensating for" Durbin in any way, said Stuart Weiner, former director of payments research at the Kansas City Fed who now is an independent consultant and on the faculty at Kansas State University's finance department. "And, of course, the Fed's ACH pricing won't be done in a vacuum — it has [the Electronic Payments Network] as a competitor." That network is operated by The Clearing House Payments Co. LLC.

All U.S. ACH transactions pass through either the Fed or through the Electronic Payments Network, the nation's sole ACH operators. That means the Fed also must tread carefully in setting debit network rates for what essentially is a competing transaction method to ACH payments.

Instead of trying to put PayPal out of business, or attempting to alter ACH pricing to produce that effect, the Durbin amendment actually gives banks incentives to work with alternative payments providers, Bezard said in his report. PayPal, a unit of eBay Inc., already is pursuing relationships with banks, he said.

"PayPal could see the opportunity to actually pay banks the equivalent of an interchange fee (probably set higher than a regulated card interchange but lower than today's debit card interchange) in exchange for having banks aggressively promote PayPal to their customers," Bezard wrote.

Bezard's report also includes other predictions for how the Durbin amendment and the recent settlements by Visa Inc. and MasterCard Inc. with the Justice Department could reshape the U.S. payments industry.

Among them are banks' continued commitment to debit cards and increased issuer involvement in merchant-funded rewards.

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