President Obama is widely expected to sign the banking reform act that Congress approved July 15, but practical considerations in implementing the legislation’s debit card interchange provisions could wipe out the protection lawmakers established for smaller institutions, concludes a report banking research firm Celent LLC released this month.
Lawmakers in May introduced a debit-interchange reform clause into the broader legislation and in June added certain clarifications. But it remains to be seen specifically how new debit card interchange rates will be applied and enforced, particularly among smaller banks, Zilvinas Bareisis, a Celent senior banking analyst, writes in the report.
The report supplements an earlier analysis Celent published on the topic before the lawmakers’ clarifications (
The law calls for the Federal Reserve Board to set new “reasonable and proportional” debit card interchange rates based on issuers’ card-program costs within nine months of the bill’s passage. The new rates would become effective 12 months after the bill’s enactment.
One of the biggest uncertainties surrounding the proposed law is its exemption from any changes to debit-interchange rates for institutions with less than $10 billion in assets designed to protect smaller banks from potential revenue losses.
Given the complex structure of debit-interchange rates based on transaction type and merchant category, networks and merchant acquirers likely will find it impractical to maintain different rates based on an issuer’s asset size, as the law stipulates, Bareisis contends.
The effort to maintain data supporting different interchange rates for issuers of differing asset sizes “would have to be updated as issuers grow (or diminish) in size and cross the $10 billion threshold, or, more likely, as they renegotiate their fees with the Fed,” he notes.
Following “an intense debate” with industry participants during the consultation period while the Fed determines the new rates, “the industry will settle on lower (interchange) fees across the board,” Bareisis predicts.
The analyst also warns that under the proposed U.S. legislation, interchange rates could drop to the point where all issuer profits are eliminated. One reason is that the proposed U.S. interchange rules significantly lack any “clearly articulated objectives,” unlike those of banking regulators in other countries that have tackled interchange regulation, he contends.
European regulators, for example, have been active in trying to reduce card interchange rates, Bareisis writes. But in Europe, regulators’ motives have been clearly defined, centering on “ensuring competition (particularly among merchant acquirers), ensuring benefits to consumers, transparency, and implementing a single European market” by leveling cross-border interchange rates, Celent says.
Bareisis concurs with other analysts that it is fairly certain the proposed legislation will tip the balance of debit transactions toward PIN-based cards and away from higher-cost signature debit. “Currently, many issuers are actively promoting signature-debit cards, and this change would remove a lot of the incentives for them to continue those promotions,” he says.
Issuers likely will be spared any immediate credit card interchange regulation, which has been a looming threat for several years, the analyst speculates. One reason is because of the complexity and diversity of credit card programs and the specific risks issuers bear in offering credit cards that makes determining their costs difficult.
“It will take time for the dust to settle” in the industry after debit-interchange regulation, noting “the experience of other markets, particularly Australia, should further discourage the regulators from meddling with credit card interchange,” Bareisis contends.
To brace for debit-interchange regulation, Bareisis advises banks to analyze their checking account customers’ behavior and take appropriate actions to improve profits. Issuers might devise ways to cross-sell credit card products to customers generating the most debit transactions to offset the loss of debit interchange.
Banks also could improve efficiencies by encouraging heavier debit card use among customers that use debit cards least often, thereby making up for lost fees through increased overall transaction volume, Bareisis says.
Banks might also want to consider packaging payment products more strategically, positioning debit as “cash-access” and other cards, including prepaid cards, as shopping vehicles, Bareisis says.
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