Certain card issuers grappling with the fallout of new and pending regulations are beginning to recognize that a dramatically different approach to designing payment products may be needed to cope with even more potential regulatory changes ahead.
Major initiatives that have emerged so far from Congress and federal banking agencies in recent years to rock the card industry include the Credit Card Accountability, Responsibility and Disclosure Act, which sharply cut issuers’ income from interest rate increases, penalties and fees when it went into effect last year; new rules surrounding debit-overdraft fees that cut issuers’ revenues by billions; and proposed Federal Reserve Board rules that would reduce issuers’ debit-interchange revenue by some 70% by capping rates at 12 cents per transaction.
Certain issuers may be looking forward to a respite from reforms, but some experts believe the intervention into the payment industry is not over. As such, issuers should prepare for the possibility of more new mandates from government agencies, payment networks and security providers in the next few years.
“Card issuers had many new rules imposed on them in the last few years, and while they kicked and screamed, the U.S. card industry still lags behind the rest of the world in the way payments are priced, how we are handling payment card security and the inevitable movement toward mobile payments,” Steve Mott, a principal at BetterBuyDesign, a Stamford, Conn., tells PaymentsSource. “I wish banks would initiate these things, but I’m afraid more government mandates will be needed to turn the industry into a fair, efficient, competitive and secure digital payments system.”
The details of certain key new regulations have yet to be finalized, such as the so-called Durbin amendment within the Dodd-Frank Act, which would cap debit interchange. But more legislation or Fed rules are likely to emerge in the next few years, such as restrictions on prepaid cards and even on credit card interchange, which so far has escaped government intervention, observers say.
And in July the new Consumer Financial Protection Bureau, created as part of the Dodd-Frank Act, will open its doors and begin investigating consumer complaints on a wide variety of banking products, including payment cards.
“With this new bureau, we are going to see a much greater focus on fair-lending issues related to credit cards,” says Michael Brauneis, director of regulatory risk in the Chicago office of Menlo Park, Calif.-based consulting firm Protiviti Inc.
“There will be an eye on lending patterns, pricing and underwriting to make sure products are offered fairly to everyone, and issuers need to start thinking about how their products may stand up to that kind of scrutiny.”
Banks that offer payment services have no choice but to start “designing products around what consumers need and finding ways to offer it to them in consumer-friendly ways that add genuine value,” Mott says. “And if they don’t step forward and make a lot of changes, I’m afraid the government will be forced do so.”
Recommended strategies include adopting new customer-segmentation and marketing strategies to identify new products suitable for specific customer types instead of taking a one-size-fits-all approach, Mott suggests.
For card issuers seeking to devise new products to meet the marketplace’s fast-changing needs, a close examination of the changing consumer landscape may be required, a group of analysts concludes in “Winning After The Storm: Global Payments 2011,” a Boston Consulting Group study released in February.
In the report, the researchers said they expect the effects of the Credit CARD Act, for example, to be “long lasting, which will intensify competition for a shrinking group of attractive (credit card) customers, (while) lower-value customers will face limited access to credit.”
Issuers are advised to improve their risk-management skills, including identifying a profitable price and appropriate credit limit when approving a new account, and analyzing changes in each account’s spending patterns with more-sophisticated tools, the firm says. Such strategies could also help issuers pinpoint opportunities to offer certain customers merchant-funded rewards, where appropriate, Boston Consulting Group advises.
Some issuers may abandon the subprime credit card market altogether and begin to charge customers for debit card accounts, depending on their other relationships with an institution, according to the study.
Because the Credit CARD Act prevents card issuers from raising cardholders’ interest rates when their borrowing patterns indicated higher lender risk, issuers could offset that factor by offering higher-risk customers new types of products, such as a hybrid credit/charge card. Such a product could enable a cardholder to pay off his balance automatically at the end of each payment cycle from a designated account, the researchers suggested.
Such a hybrid card could also enable cardholders to select certain types of transactions that would be paid immediately or classified as credit transactions, according to Boston Consulting Group.
“The interchange gap, if not eventually regulated away, is sufficiently large ... to warrant product innovation,” the study’s authors wrote, noting that the emergence of new technology such as alerts and customized controls provide rich opportunities for developing new products enabling consumers to choose to pay for specific types of purchases through various accounts or card types.
As long as credit card interchange remains relatively higher than debit card interchange, affluent customers with high purchase volumes will continue to be lucrative. And issuers capitalize on that by designing new products with better-customized, more-intriguing concierge-level services, rewards and fee-waivers, the study suggests.
The likely emergence of mobile payments also presents an opportunity for issuers to enhance their reach and prepare to meet new payment-security requirements. To capitalize on that opportunity, issuers should think strategically in order to make the right investments and form appropriate alliances with payment networks, telecommunication companies and makers of smartphones and other devices that may be used to make mobile payments online and at the point of sale, the firm advises.
“Knowing where your strength lies in the value chain, as well as how to successfully partner and extract value, will be the key,” the consultants contend.
New credit card products may help issuers retain valuable customers, but sharpening existing debit card products also will be crucial to surviving new debit-interchange regulations, says David Stewart, a senior expert with McKinsey & Co.
Younger consumers, which show a strong affinity for debit cards, will continue to expand the market, and it is important to cater to their debit preference, Stewart says, noting that twenty-somethings have an aversion to credit cards that is not likely to change anytime soon.
“Card issuers may earn less interchange from debit card customers, but debit users are a very important group that will continue to want to use debit,” he contends.
“We have to figure out ways to serve debit users, even with lower interchange, and find ways to make the economics favorable,” he says. Examples include driving more routine payments from automated clearinghouse channels, which produce little to no revenue, to debit channels, Stewart says.
“Debit is very sticky product, and it will continue to matter in the future. Do your cost-benefit analysis on debit products based not on the (pre-Durbin amendment) economics but on the new economics, and find a way to make it profitable,” he advises.
Card issuers face steep challenges in coping with new and pending regulations that are changing their business models. While further regulations may be forthcoming, issuers have a near-term opportunity to devise new products that balance profitability and risk-management with changing consumer preferences and marketplace demands.
