The financial industry should be very concerned that access to its databases is being "sold" for considerably less than it costs.
In recent years, as the number of online PIN-based point of sale transactions has grown into the billions, financial institutions have argued that the reimbursements do not cover their "costs" for online authorization.
Third-party studies suggest such complaints are indeed valid. Efforts got under way in 2001 to increase the payment made to banks, savings institutions, or credit unions for these transactions. These attempts precipitated a controversy that has raged between payment companies and merchants since late last year.
It is important to understand the purpose of the "interchange fee" - or the fee paid by the merchant to the card-issuing institution - in these transactions. The term is borrowed from the credit card business, but in this case it is more appropriate to call it an "issuer authorization fee" since it applies to authorizing a transaction on a real-time basis. However you label it, this fee is intended to compensate card issuers for their costs (and presumably provide a reasonable return).
Since it is practically impossible to have a distinct authorization fee for every single financial institution, these rates historically have been based on an "average" cost. As the fee debate broadened in scope and intensity, one could hardly blame the merchant community for trying to negotiate the lowest possible charge for authorizations. Retailers, meanwhile, have increasingly encouraged consumers to use "PINned" POS transactions since it is one of the most efficient and cheapest forms of electronic payment.
Such transactions are growing by more than 25% a year. This year alone, there will be an estimated six billion in the United States. So a savings of a few pennies per transaction, particularly for large merchants, will translate to major expense reductions.
Visa U.S.A. jump-started discussion of higher POS interchange fees in 2001 when it tried to raise the fee paid to issuers for Interlink transactions. It undoubtedly wanted to act in the best interests of its Interlink issuers when it announced significant increases.
Unfortunately, Visa's well-intentioned efforts were perceived by merchants as aggressive and unjustified. The proposed increases met stiff retailer resistance. Some merchants even decided to curtail acceptance of Interlink cards. To salvage its online POS program, Visa then offered a new set of "tiered" fees. These rates represent a reduction in the interchange fees paid by the largest merchants.
Several other payment companies adopted tiered rates similar to Visa's. All of them will raise the fees paid to card-issuing institutions by smaller merchants, but those paid by larger merchants will go down. Depending on the mix of transactions, financial institutions' reimbursement for their costs may fall or go up slightly. But in either case, they still will not be fully reimbursed.
The financial industry's cost of authorizing online POS transactions does not vary by merchant type, purchase amount, or size of merchant. So it needs to understand that, to a degree, what is really happening is that some payment companies are "discounting" the card-issuing institution's fee income in order to secure merchant transaction volumes.
The industry overall is only somewhat closer today to the full recovery of its costs than it was when the fee imbroglio began. While it may be impractical to negotiate full recovery in the near term, it is reasonable to expect fair reimbursement for allowing third-party access to its most valuable resource - the customer database.
This issue has strategic implications for the entire financial community, since merchants and third parties increasingly seek access for the expanding base of electronic transactions. Unfortunately, new rates have been negotiated, and in large measure the expectations of card issuers have not been met.
Over the next several years, the financial industry could lose billions of dollars in revenue. And many institutions have begun to realize the consequences of selling access to their databases below cost.
Guaranteeing electronic payments represents value far beyond just the hard cost of authorization. In the end, denying a financial institution an adequate return for this may be just as significant - economically and in other ways - as the ATM-surcharge issue.
