The Brewing Storm Over PIN-Debit Fees

  The debit card world, already trying to recover from bruising interchange fights with retailers, could soon face another operational jolt.
  Congress is questioning whether debit card issuers are adequately informing customers that the cardholders may be charged fees for initiating personal identification number-based point-of-sale transactions. Issuers reap the benefits of such fees, but merchants and merchant acquirers often take heat from consumers because of them.
  The U.S. Senate Committee on Banking, Housing and Urban affairs has instructed the Federal Reserve Board to solicit comments on whether existing disclosures required under the Electronic Funds Transfer Act are sufficient. The comment period ended in July, and the Fed will present its report to the committee in November.
  But regardless of the findings, the scrutiny further illustrates the precarious state of debit pricing, and how fee models could again come under attack from government, consumer or merchant groups, particularly if additional issuers join the list of institutions assessing PIN-based POS debit fees in an attempt to generate income or entice cardholders to initiate more-lucrative signature-based debit transactions.
  "Banks shouldn't charge people who use online debit cards because it is a more efficient way to initiate transactions," says John Hamby, senior vice president and manager of the Merchant Services Center for New Haven, Conn.-based NewAlliance Bank. "It could drive more consumers back to paying with cash and checks at the point of sale, and the institutions could lose many customers in the long run."
  The disclosure concerns follow last year's settlements in a class-action antitrust lawsuit bought by Wal-Mart Stores Inc. and other merchants against Visa USA and MasterCard International. Those agreements resulted in the slashing of signature-based (offline) debit interchange rates in the last third of 2003, and gave credit card-accepting retailers the option to either accept or decline the associations' offline debit products. Visa and MasterCard raised debit interchange this year, but rates generally are still below their pre-settlement levels.
  But because interchange-the amount of a card sale that the merchant acquirer must pay the issuer and which acquirers typically pass on to their customers-on offline transactions still typically is higher than PIN-based (online) interchange, some issuers are charging for PIN-based purchases in an effort to generate more offline activity. Fees typically range from 25 cents to $1.50.
  In a nationwide Internet survey of personal checking account holders conducted in May by Collective Dynamics LLC, an Atlanta-based management consulting firm specializing in payments, 9% of the 970 respondents indicated that their issuer charged a fee for online debit card use at the point of sale, while 4% noted that they were charged for initiating signature-based purchases. The survey has a margin of error of plus or minus three percentage points.
  Despite such pricing, debit card activity continues to accelerate. In 2003, purchase volume on the signature-based Visa check card and debit MasterCard products rose 21% to $386 billion from $317.7 billion in 2002. And the 12 electronic funds transfer networks that support PIN-based POS debit switched 522.8 million purchases in March, up 25% from March 2003 ("The EFT Networks' Mixed Results," page 38).
  Riding the debit wave is the Ontario, Calif.-based Co-op Network, the fifth-largest EFT network. Co-op reports that its online POS volume in July was up 35% from a year earlier, while signature debit activity increased more than 40%.
  Strong Growth
  Strong growth is occurring even though an undetermined number of Co-op's credit-union members charge their cardholders for initiating debit transactions, says James A. Hanisch, executive vice president.
  "We encouraged members not to overreact to the Wal-Mart settlement (and the resulting lower offline interchange rates) by instituting consumer fees to compensate for the loss of revenue," he says. "It is better that the institutions grow their way out of the decline. The vast majority took that approach, and many already have offset the dip in interchange with added volumes."
  Hanisch says he fears that consumer POS fees could become widespread if slowly rising interest rates-which could harm institutions' earnings-force more issuers to search for new income sources.
  Stan Paur, president of the Houston-based Pulse EFT Association, the fourth-largest EFT network, says issuers could face antitrust lawsuits if online debit fees become prevalent. But he notes that he expects few additional institutions to start charging consumers for POS debit because online interchange rates are steadily rising, and more merchants are installing PIN pads. Pulse's 2004 POS volumes are 25% higher than projected, Paur adds.
  Pulse and many other major EFT networks increased their online POS interchange fees within the last year. Pulse issuers receive 18 cents for online transactions, up from 15 cents. In contrast, offline card issuers typically receive between 26 cents and 53 cents in interchange on a $40 signature-based debit purchase. Visa/MasterCard fees vary based on overall transaction volumes and merchant categories.
  Waiving Fees
  Among the institutions with PIN-based debit fees is Cleveland-based KeyBank, the 16th-largest online issuer. Key Bank charges cardholders 25 cents for an online POS transaction to cover its administrative expenses. However, the fee is waived for the more than 70% of customers who maintain minimum balances or meet other requirements, says Carl Stauffeneger, KeyBank senior vice president.
  This desire to cover program costs also prompted Baltimore-based Carrollton Bank to charge cardholders 50 cents for each PIN-based debit transaction. But the institution, a leading debit acquirer, will drop the fee soon because the growing number of retailers supporting online debit is leading to greater interchange revenues, says Gary Jewell, senior vice president.
  He notes that the bank's acquiring business this year is seeing a 60% to 70% increase in the number of merchant locations accepting online debit, and volumes are up 25%.
  And more consumers appear to favor debit over most other payment vehicles. A nationwide study by the Washington, D.C.-based American Bankers Association and Boston-based Dove Consulting found that in 2003 31% of in-store purchases were initiated with a debit card, compared with just 21% in 1999.
  Cash was used for 32% of transactions last year, down from 39% in 1999, and checks accounted for 15% of purchases against 18% in 1999. Another 21% of transactions were initiated with credit cards, down from 22%. The figures are based on data from 2,008 consumers who responded to paper and Web-based surveys.
  As debit card activity becomes more prevalent, squabbles over whether disclosures of transaction fees to consumers are adequate are likely to become more pronounced.
  Current guidelines under the Electronic Funds Transfer Act require financial institutions to make initial disclosures at the time a consumer contracts for an EFT service or before the first funds transfer is initiated. Fee disclosures also need to be included in the periodic statements that must be sent for each monthly cycle in which an EFT occurred, and at least quarterly if no such transfer was initiated.
  In examining the need for further disclosures, the Federal Reserve Board solicited comments on the prospect of requiring additional fee information on each periodic activity statement; the listing of the amount, source and recipient of each fee; and the total amount of fees for the period and calendar year to date.
  In her response to the board, Nessa Eileen Feddis, senior federal counsel for the American Bankers Association, wrote that existing mandates "are more than adequate to inform and alert customers of these fees." Adding to the disclosures, she noted, will achieve little in terms of educating customers and will impose unnecessary system programming costs.
  Distractions?
  Feddis stated that highlighting debit card fees would distract customers from noticing other financial-institution charges that could be even more significant to them, and that including in periodic statements a summary of the total amount of such fees for the reporting period and year would unnecessarily lengthen the statements.
  "The sheer visual effect of multiple line items of the same fee, which are typical today, has the greatest impact," she wrote.
  While some parties, including the Washington, D.C.-based National Retail Federation, say consumer debit card fees should be displayed at the point of sale, Feddis noted that the technical challenges for merchants to do so would be immense, with consumers ultimately bearing the cost.
  Indeed, to disclose such data at the checkout counter, retailers would need to know the individual pricing schedules for each issuer, the type of accounts held by every cardholder, and if customers had the necessary balances to waive their institutions' POS fees.
  "It would require a vast restructuring of the POS transaction messaging systems and formats and would cost in the hundreds of millions, if not billions, of dollars," says David Lott, a partner at Collective Dynamics. "It is a technological challenge that is so expensive that it is impractical."
  Nevertheless, the NRF in its comments to the Fed stressed the need for fee disclosures at merchant locations. Such information, the organization suggested, should include the name of the institution receiving the fee, and a notice to consumers that the issuer already is receiving interchange income for the transaction.
  "Annual and periodic statement disclosures are insufficient," the NRF stated. "They get buried among a host of other disclosures and are rarely clear. Only a concrete disclosure at the point of sale will allow consumers to effectively comparison shop among banks and encourage efficiency in the marketplace."
  Angry Shoppers
  Mallory Duncan, the National Retail Federation's senior vice president and general counsel, notes that senior executives from major retail organizations have told him that many of their customers mistakenly think after reading their bank statements that the issuer fees are assessed by the merchant. Such charges not only alienate customers, but they also require retailers to take the time to explain to disgruntled shoppers that their financial institution-and not the merchant-is responsible for the fees, Duncan says.
  Instead of charging consumers PIN debit fees, debit card issuers should enhance the value of their products to generate more activity, says Debra Rossi, executive vice president of e-payments for San Francisco-based Wells Fargo & Co., a leading debit issuer and merchant acquirer. Methods can include providing exceptional customer service or tying cards to loyalty programs.
  "If the value is there, the customer will step up to the product," Rossi says. "There then is no need for fees that provide an incentive or disincentive."
  While most issuers are unlikely to soon alter their preference for signature-based transactions, the measures they take in managing and setting fees for all debit products will help to determine if their programs will be prosperous or problematic.