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Decoupled-debit cards are a relatively new addition to the payments landscape. But the newcomer has added another reason for bankers to lose sleep at night.
Cards that draw funds from checking accounts held by other institutions using the automated clearinghouse system have been around for more than a decade, and the market once appeared on the verge of fading away. That changed, however, when two major payments players, Capital One Financial Corp. and HSBC Finance Corp., last year launched decoupled-debit pilots.
Now many bankers fear that if they fail to respond, either by entering the decoupled-debit market or by redesigning their card-rewards programs to compete, they face losing the valuable interchange revenue they earn from transactions made with their debit cards.
"Bankers are all abuzz about this one," says Larry De Palma, president and CEO of TDG-Phenix, a Brentwood, Tenn.-based payments consulting firm. "It poses an incredible risk to interchange, to future deposits, to basically what they know as their debit program right now. You get a marketing machine like Capital One introducing a product as innovative as this with the resources behind them, and every banker in the country should be watching this very diligently."
Capital One launched its decoupled-debit pilot last spring and is continuing to test it on a limited basis.
"This product allows us to deepen our relationships with customers and to market debit cards on a national basis outside our existing retail branch footprint," explains Pam Girardo, a Cap One spokesperson.
In late 2006, HSBC and San Mateo, Calif.-based Tempo Payments Inc. introduced cobranded decoupled-debit pilots with CVS/pharmacy in the Indianapolis area and with the Pathmark grocery chain in the Mid-Atlantic region.
Though decoupled debit will enable consumers to use debit cards issued by financial institutions other than their own banks, and thus potentially disrupt the traditional relationship between banks and their demand-deposit customers, the concept is not that radical.
In fact, decoupled debit follows the very path the credit card industry staked out two decades ago.
Initially, banks issued credit cards only to their own customers. Now the credit card market is a free-for-all, with consumers besieged by card offers that dangle enticing
rewards programs.
Debit cards have surpassed credit cards as America's favorite payment vehicle.
Issuers earned about $8.4 billion from debit card usage in 2004, a figure expected to reach more than $21 billion by 2009, according to McKinsey & Co., a global consulting firm with 90 offices in 50 countries.
Debit card usage has been growing at 17.5% annually, or at least three times that of other payment forms, according to Daniel Eckert, HSBC head of venture, acquisition and development. Credit card transactions, for instance, have grown at a rate of 4.6% annually.
With vast sums of money at stake, it is not surprising that such companies as Capital One, Tempo and HSBC would like to use reward-laden debit card programs to lure away customers from banks whose debit card programs are tied to their own accounts.
Financial institutions have yet to compete for debit card customers with reward and loyalty programs the way they do with credit cards. Decoupled debit, if it proves
profitable, would change all that.
Acquisition Tool
"Decoupled debit is a significant change in paradigm," says Mike Grossman, CEO of Tempo, which has been experimenting with the concept for most of this decade. "For the first time, debit cards can be used as a new-customer acquisition vehicle. Some banks will end up winning, and others will be adversely affected."
The losers are likely to be those issuers that fail to add rewards to their debit card programs.
"Banks will have to enhance their rewards programs to keep consumers," predicts Jonathan Silver, CEO of Affinity Solutions, a New York-based firm that develops marketing and rewards programs for banks and retailers. "If you're the incumbent, you've got to raise the bar."
Issuers that decline to provide debit rewards or that do not issue decoupled cards could lose more than customers and interchange revenue. They also may have to pay ACH fees when funds are taken out of their own customers' accounts, according to De Palma and Manjot Sohi, leader of the banking practice at Capgemini North America, a consulting firm headquartered in Paris.
According to Sohi, with decoupled debit, banks would pay one cent per every 100 ACH transactions that tap into their customers' demand-deposit accounts to draw funds for payments made at the point of sale.
By comparison, merchant banks pay card issuers about 1.15% of the transaction amount in traditional signature-debit interchange, according to De Palma.
Banks "go from a revenue-earning proposition to an expense," he explains. "You've lost a percentage of the transaction, and now you have to pay because the item comes through your system as an ACH debit."
On the other hand, issuers that gain new consumers through decoupled debit instantly have new customers to whom they could promote all their banking products, including demand-deposit accounts, health savings accounts or student loans.
Banks that lose an accountholder's debit card business to another issuer could try to charge that customer a fee every time an ACH transaction takes funds out of the customer's account, according to Tyson Nargassans, president of Saylent Technologies of Franklin, Mass. Of course, such a fee could risk alienating customers and prompt them to choose different banks, he adds.
Card Integration
An online survey conducted in January by Boston-based consultancy Aite Group LLC found that about one-third of current credit and debit cardholders would be interested in a decoupled-debit card, largely because of the chance to win extra rewards.
HSBC, the third-largest issuer of credit and debit cards in the U.S., views its decoupled-debit venture with Tempo as a vital part of a broader payments-innovation strategy to generate more customers and move into underserved markets through an integrated debit and credit card product. "We saw this as expanding our geographic reach without having to make a significant investment in bricks and mortar," says Eckert.
Grossman says Tempo has learned two positive lessons through its decoupled debit pilot: Consumers like using the cards, and the risk issuers of the decoupled cards face does not stand in the way of their making profits (see sidebar on page 18.)
Some issuers that offer decoupled-debit cards will have to decide whether they want to cobrand with certain merchants. Under such an arrangement, the merchant can negotiate a lower interchange rate, while the issuer can gain customers through a merchant's marketing and promotional power, particularly if the merchant is a major national retailer.
In early versions of its decoupled-debit card, Tempo served as the network and set its own interchange rate. Now, in its partnership with HSBC, Tempo has moved away from its network role, and MasterCard sets the interchange rate.
Most experts in the financial and payments industries view decoupled debit as a boon to consumers. As decoupled debit heightens competition among banks, issuers will offer more products–and choices–to consumers tied to their debit card usage.
"Decoupled debit affords more freedom to the consumer," says Eckert. "It gives them choice without any painful side effects."
More Mail?
Well, almost without pain. Some experts suggest that debit card issuers will bombard consumers with solicitations once the decoupled field opens up. That means a surfeit of mail, phone calls and Internet enticements as the various debit card issuers seek to enroll customers in their programs.
Some consumers might end up carrying more than one debit card in their wallet, just as many individuals today have several credit cards. The danger in carrying multiple debit cards is that individuals might find it hard to keep track of their balances to avoid overdrawing their
accounts, says Deborah Thoren-Peden, a partner and co-leader of the consumer and retail division of the San Francisco-based law firm Pillsbury Winthrop Shaw Pittman LLP.
Indeed, not everyone sees clear sailing ahead for all issuers interested in decoupled debit.
"I'm not so sure the smaller players will be able to be successful on a national level," says Joseph Polverari, senior vice president of strategy and development at Yodlee Inc., a Redwood, Calif.-based firm that helps banks develop online-payment programs such as direct bill pay.
Regional Vs. National
Polverari believes companies such as Tempo might have better success on a regional level than in trying to issue decoupled cards nationally. He says financial institutions are looking at decoupled debit as a means to retain and acquire customers, but banks traditionally take a cautious approach when it comes to implementing such new ideas.
"Changing consumer behavior is difficult," he says, noting behavioral change must occur if issuers are to convince cardholders of the benefits of using different debit cards.
That is why De Palma and others anticipate that smaller, more-nimble banks might be quicker to jump on the decoupled concept than will large banks with national footprints.
"Most large banks are so overwhelmed by mergers and system integration that they don't have all the resources they can apply, like Cap One, to innovation," De Palma says, implying that big banks have higher priorities than initiating decoupled-debit programs.
Market Pressures
Nargassans says the decoupled movement could force traditional debit card issuers to better analyze the demographics and behavior patterns of their customers, something few traditionally have done.
"Banks, which have sat on comfortable growth for an extended period of time, now have got to generate more use and understand the customer better," he says. "They need to create intimacy with their customer better and create a bond. They just haven't had a good grasp of their debit users the way credit card issuers have."
Decoupled debit has yet to emerge in any country outside of the United States, according to Capgemini's Sohi. That could change, however, if the decoupled market gains traction in the U.S.
"At this stage, we don't know if it's profitable," says Sohi. "But if it succeeds in the U.S., issuers will definitely try to see if it works in other places."
Many experts anticipate such success with decoupled debit and see it as the forerunner to even more changes in the debit card market.
"This is the first step to gauge if there's innovation to be had in debit cards," says Nargassans. "This is competitive innovation. Can somebody detach me, the consumer, from my bank for this type of transaction? And if it is successful, there will be other innovations. The [independent sales organization] market would attack it like they did ATMs. This is the first step."
And it is a first step banks need to be watching closely. If they wait too long to explore the possibility of decoupled debit for their institutions, they may find that some of their customers are flocking to banks that lure them away with lofty debit rewards programs. CP
