Current economic conditions have brought about significant changes when it comes to consumers' use of debit rather than credit.

Tightened consumer credit combined with the fading of the "buy now, pay later" mentality has renewed consumer focus on savings and fiscal responsibility. As a result, increasing numbers of bank customers are putting down their credit cards and using debit cards for everyday purchases.

It is inevitable that we will begin to see a steep increase in the use of merchant-funded, transaction-based debit rewards programs by banks of all sizes to compete for market share. Increased use of this type of program is especially likely when banks learn of its cost-effectiveness, its ability to reduce dependence on interchange, its potential impact on customer loyalty and its revenue-generating capabilities.

Transaction-based debit rewards programs, funded by merchants, tend to be extremely cost-effective relative to other channels. Merchants are willing to incur the costs associated with this type of rewards program since access to customers' unique transaction data makes possible a precise form of targeted marketing that offers relevant rewards to current customers or prospects they want to win over.

Offers can be made to bank customers directly in their online bank accounts. This is beneficial since it increases the chances that customers will actually view and respond to the offers; a March 2009 study by HSBC Direct said that more than 63% of consumers manage their banking online.

Merchants' funding of this type of program can save banks billions of dollars now being spent to fund rewards programs that direct customers to third-party Web sites to redeem rewards. Such programs offer merchants little or no targeting capability, whereas transaction-based targeting is extremely accurate.

Banks can use transaction-based rewards programs to affect customer loyalty positively. Since these types of programs use secure transaction data, customers are only presented with relevant rewards based on their individual behavior. As a result, average users can save $100 to $200 per year, and active users can save any amount up to and above $1,000. These savings are earned on products the person would have bought anyway — either online or at retail stores where they normally shop.

When the rewards are presented in line-item account statements, customers get the perception that their bank, not the merchant, is rewarding them. Likewise, these programs do not require customers to exit their online banking pages to redeem a reward. This is important because research shows that consumers have learned that "clicking out" of their banking site is risky from a security perspective.

Finally, transaction-based debit rewards, funded by merchants, can turn banks' debit programs into profit centers. Relatively low interchange amounts account for debit cards' thin current profit margins. However, transaction-based rewards systems require that customers use the debit cards that their accounts are tied to instead of having to deal with paper coupons. This convenience prompts customers to further use their debit cards to redeem the rewards, thus driving revenue-generating account activity.

Because of the changing financial landscape we are likely to see banks increase their use of debit rewards to attract and retain customers. However, transaction-based debit rewards that are merchant-funded will probably be the reward system of choice because it increases banks' revenue without requiring them to fund the rewards. It also will help banks build valuable relationships by letting customers conveniently save money on products they already buy.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.