Seeking ACH-Fee Hike Seen As One Option To Compensate For Reduced Interchange Revenue

Financial institutions looking to make up for revenue lost should debit card interchange rates dramatically drop next year could target what increasingly has become a thorn in their side: third party automated clearinghouse debits from their customers’ checking accounts, new research suggests.

Competitors for years have been able to use the ACH system to tap into debit card issuers’ checking accounts. EBay Inc.’s PayPal unit thrives on it, and Tempo Payment Systems uses ACH debits to promote so-called decoupled debit cards.

As such, the ACH network “stands as a prime candidate for pricing reassessment,” concludes a new Aite Group report “The New Order: How Interchange Regulation Will Change the U.S. Payment Industry.”

Though banks for years have expressed concern about the “free ride” the ACH network has given to alternative payments providers, as long as the institutions could generate hefty revenue from other sources, such as lending, overdraft fees and card interchange, serious talk of tackling the issue was not a high priority, writes Gwenn Bézard, Aite senior research director and the report’s author.

Mike Grossman, Tempo CEO, says the ACH fees his company pays "are relatively low, all things considered."

Depending on the transaction volume a company tapping in to a bank's checking accounts via ACH withdrawals, the per-transaction fee could be less than one cent, Grossman says. "We're higher" than that amount, he says, declining to discuss specific pricing.

As mandated by the Durbin amendment in the Dodd-Frank Act, the Federal Reserve Board later this month could issue proposed payment card network guidelines for the setting of “reasonable and proportional” interchange rates (see story).

Many observers believe the Fed will propose sizable rate reductions, resulting in substantial decreases in debit card issuer revenue. Aite says issuers can expect interchange revenue to drop by 40% as the rates become cost-based.

The largest U.S. card issuers could lose more than $2 billion annually in debit card-related revenues from the combination of new regulations cutting into overdraft fees and pending debit-interchange regulation, according to a new report from Javelin Strategy & Research (see story).

“Since the Durbin amendment limits interchange regulation only to transactions flowing over payment card networks, banks should face no regulatory obstacles to addressing ACH pricing,” Bézard notes in his report. “A number of banks also feel like the rising fraud issues associated with ACH transactions, and the liability carried by banks, should alone justify a review of the pricing model.”

Depending on the extent banks succeed, it could have dramatic effects on the market. “A significant rise in ACH costs could literally put PayPal out of business,” Bézard notes. PayPal representatives were not immediately available to comment.

In an interview, Bézard conceded that banks will face challenges trying to significantly increase ACH prices. “We’ll see strong efforts to raise the ACH fee. Will it be a lot? Probably not. But they will try to close the loophole,” he said.

Indeed, the Fed will be very careful not to appear to be circumventing or “compensating for” Durbin in any way, notes Stuart Weiner, former director of payments research at the Kansas City Fed who now is an independent consultant and on the faculty at Kansas State University’s finance department. “And, of course, the Fed’s ACH pricing won’t be done in a vacuum–it has [Electronic Payments Network] as a competitor.”

All U.S. ACH transactions pass though either the Fed or through the Electronic Payments Network, the nation’s sole ACH operators. As such, the Fed also must tread carefully in setting debit-network rates for what essentially is a competing transaction method to ACH payments (see story).

Instead of trying to put PayPal out of business, or attempting to alter ACH pricing to produce that effect, the Durbin amendment actually gives banks incentives to work with alternative-payments providers, Bézard notes in his report. PayPal already is pursuing relationships with banks to become their preferred person-to-person payments network, available through their online and mobile channels, he notes.

“PayPal could see the opportunity to actually pay banks the equivalent of an interchange fee (probably set higher than a regulated card interchange but lower than today’s debit card interchange) in exchange for having banks aggressively promote PayPal to their customers,” Bézard wrote.

Bézard’s report also includes other predictions for how the Durbin amendment and the recent settlements by Visa Inc. and MasterCard Worldwide with the U.S. Department of Justice (see story) could reshape the U.S. payments industry.

Among them include banks’ continued commitment to debit cards; increased issuer involvement in merchant-funded rewards programs; greater growth potential for regional debit networks; more opportunities for prepaid card products; a U.S. chip-and-PIN mandate by 2015, which would accelerate adoption of contactless terminals; and fatter margins in the short term for acquirers that do not pass along all of the interchange-cost reductions to their merchant clients by lowering their discount rates.

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