“Fee Cap” consists of two three-letter words that strike fear into the hearts of any business executive in any industry. Seeing those words as connected to your business means only one thing – your profits are going to get trashed and you’ll need to figure out another way to recover the profits that your investors or shareholders had grown accustomed to seeing. It also probably means that government regulators or courts felt that, left you to your own devices, you’d have run roughshod over innocent women and children with your pricing practices as you beat a path towards record-high earnings.
The already highly regulated financial services industry saw those two three-letter words applied to them and their debit products in bold and ALL CAPS in 2010 when the Durbin Amendment was introduced. All of you know how that story ended, so there’s no need to rehash it here. (For those of you with a voracious appetite for payments history though, feel free to jump into the whole saga.)
The industry also thought that they had dodged the big bullet headed their way. They gave thanks in 2011 for losing only about half as many billions as they would have when the Fed went with about 24 cents per transaction instead of 12 cents or less. The industry also thought that they had dodged the big bullet headed their way. They gave thanks in 2011 for losing only about half as many billions as they would have when the Fed went with about 24 cents per transaction instead of 12 cents or less.
The payments industry thought that it had seen the last of those three-letter words, at least for a while. But that was not to be. Judge Leon’s ruling last week placed those three-letter words front and center again and brought the industry to its knees with the stroke of his pen (or more realistically, the click of his keyboard). Judge Leon apparently likes those particular three-letter words so much that he has advocated that the debit fee cap be right about where it was originally anticipated, although some contend that it could be forced even lower. The shockwaves that have reverberated throughout the industry since are rooted in a number of things, including the unprecedented nature of having a Judge reverse a Federal agency’s decision and having that Judge be a relatively conservative Republican appointee. His ruling seems to show just how little sympathy the big banks have engendered anywhere and how misunderstood the economics of the payments business are. Slashing fees on debit, as we have seen over the last year, has had a resounding impact on the ability of consumers to enjoy free checking accounts (since it is impossible to separate debit products from checking accounts). Lots of consumers have become disenfranchised from their banks as a result of having to pay more for basic checking account services and if the Judge’s ruling holds, we’ll likely see even more of that.
But, this piece isn’t going to rehash the decision or discuss the regulatory implications of it. What I’d like to talk about is the collection of three-letter words in payments that I think will be impacted by this ruling, if it sticks.
Let’s go down the list now, shall we?
Okay, so technically this is not a three-letter word but humor me. The Judge’s decision imposes even more routing requirements than the Fed’s ruling did, requirements that one might argue could be technically facilitated by the common AID concession agreed upon by Visa and MasterCard recently. That could essentially provide a path to the data that would have to be shared in order to get mag stripe interoperability to work as outlined in the Judge’s decision. But since the MasterCard and Visa AID concession did not address how the governance issues associated with assuring neutrality in routing across networks would work, it is likely to remain the payments equivalent of the Mexican standoff until that is sorted. “When pigs fly” is how some have characterized the timeframe associated with sorting this issue, which is a bit extreme, but you get the point – the Judge’s mandate for expediency notwithstanding.
Now, could the Judge’s ruling force the governance issues to be handled quickly or impose a process to make that happen? I have no idea, but if something like that were to happen, then it would basically boost EMV adoption since merchants might have a greater ability to play four or more networks against each other every time they route a transaction. What seems more likely is that the 2015 liability shift will have to be delayed, if for no other reason than to give the ecosystem time to plan for and implement the change to the systems that they just spent the last year changing to conform to the Fed’s 2011 rule.
Then, if and when that date is pushed out, I believe that the flood gates will open for more debate on EMV and we could see even more push back by the merchants who don’t really want to do it – not in 2015 or ever. Merchants understand a few things now: that they have a lot of power, that they can use that power to affect big change in payments and that implementing EMV will only tie their hands even more tightly to Visa and MasterCard. Once EMV happens, they will be locked into a technical standard, a set of rules and pricing that only the largest of the merchants will be able to negotiate down.
A slip in the date will also kick open the door to the other EMV elephant in the room: the argument that EMV is a solution for today and not the future of payments. Yes, we all intellectually understand the argument that fraud finds the weakest link and that the non-EMV chip & PIN U.S. could become the world’s weakest link. But evidence from Canada’s EMV deployment suggests that the weakest link is fraud related to card-not-present transactions, which has increased since EMV was implemented – and EMV does nothing to stop that type of fraud. Since the future of payments is mobile and cloud-based transacting, EMV does nothing to help that problem but there are a range of solutions that provide better (and cheaper) alternatives that could.
Additionally, merchants are starting to do the math, and don’t like the breakeven analysis that they are coming up with. They too believe that the future is mobile and interacting with point of sale devices that may not look anything like they do today and in ways that are very different. The large merchants at least, don’t see how the cost and effort associated with essentially becoming backwards-compatible with a technology that was introduced a decade ago, and invented even longer ago than that, to solve a problem they don’t have today is worth their time, money and aggravation.
And, finally, it hasn’t been lost on me that MCX has decided (at least as of now) to launch its mobile payments network using a bar code. The “aha” here is that bar codes don’t require new terminals, which suggests that upgrading hardware isn’t required to support their new network scheme and may not even be on the punch list in the foreseeable future. And since these merchants, who collectively account for $1 trillion or more of consumer spending, will clearly have to continue to accept Visa and MasterCard transactions until their network gets traction, they may have the power to say, as the song goes, tell them to, “let’s call the whole thing off.” The networks would have little choice but to listen, essentially delaying and even possibly derailing EMV entirely.
If I were MCX, I would run, not walk to the nearest PIN debit network and negotiate my deal, now. Why in the world would they want to have their new network run over ACH rails when they can get much richer PIN debit functionality for about the same price if the ruling holds? Seems like a no-brainer to me, and something that could even accelerate the deployment of the MCX scheme.
What’s left to say here? If the pause button is pushed on EMV, then NFC will be set further back since the rush to buy new terminals will cease, further stunting the miniscule penetration of NFC terminals in the U.S. Now, we all know that simply having a terminal capable of deploying NFC doesn’t mean that merchants will do so, but at least you have to at least have a terminal to activate it. So, if Judge’s ruling sticks and EMV slows, it will make for very a bad day back at the NFC ranch and for all of those NFC-only payments solutions.
Let me call up another three-letter acronym to describe ACH if the Judge’s ruling sticks: DOA. ACH has been positioning itself to be the rails for many an alternative payments scheme for a very long time since it is how these alternative networks could lower the cost of acceptance to merchants. One of the big drawbacks, though, has always been the lack of real time transaction interrogation capabilities that make ACH cheaper but less desirable. A couple of players, including NACHA, have been trying to change the rules and enhance its capabilities and make ACH a more plausible reality, but if the Judge’s ruling holds, why bother anymore? The debit rails will be just as cheap and have all of the advantages of real time risk and fraud management. That leads me to invoke a couple of other three letter words then as it relates to ACH and its future in payments: Bye-Bye. And they’ll take a lot of the startups that pinned their futures on ACH with them.
Okay, so here’s a contrarian view: advantage PIN networks. Let’s assume I’m right and ACH is taken out of the picture if the judge’s ruling holds. There could be a whole new set of innovators drawn to using a low cost set of rails that have real time capabilities. It’s possible that ACH’s loss will be the PIN network’s gain and even prompt them to develop new capabilities to help innovators compete with the incumbents (that they might be able to monetize in a different way).
Okay, so technically PayPal is a mashup of two three-letter words, but important to talk about. This one is complicated. On the one hand, the Judge’s ruling could prove advantageous for PayPal. A report that I read a while back suggested that 50 percent of PayPal transactions are linked to the checking account of its account holders. PayPal could use this as an opportunity to ask consumers for their debit card numbers instead of their DDA numbers since the price differential in doing so will be minimal and more consumers might be willing to attach their debit card number to their PayPal account than their checking account numbers. PayPal also has a number of tools in their tool kit that would make it pretty straightforward to incent consumers to do that easily, including their interface that allows consumers to change the funding source after a transaction has taken place.
But, on the other (I guess I have been hanging around economists too long), it could spell a bit of trouble. PayPal charges a merchant discount to the merchant and is trying to get acceptance at the large physical merchants. PayPal might have to rethink its pricing in order to be competitive with whatever blended rate merchants are paying, which is certainly going to be less than it is now, if the ruling holds. Otherwise, it might be more difficult for PayPal to get acceptance at the physical point of sale – the merchants can just say no.
Shifting gears just a bit, there’s another “three” word that could also kick into higher gear thanks to Judge Leon: three-party networks. They are totally exempt from Durbin and one big player – Chase – has already made a few moves to suggest that it’s a direction in which it is heading. Bank of America could do the same thing, although it’s a little stickier since it doesn’t own BAMS outright. Unlike the PayPal scenario, merchants would be hard pressed to refuse the many tens of millions of cardholders who would present their cards (physically or via their digital wallets) even it if cost merchants more to accept them.
All that said, as difficult as it would be for the payments industry to adjust to the ruling if it is upheld, the industry has a number of tools it could use to lessen its sting. Mobile is one six-letter word that could become even more important than it is already perceived, particularly for the issuers who would be seriously disadvantaged if the ruling is upheld. Not only will mobile provide merchants and consumers with a new way to interact and communicate before, during and after the transaction, but issuers will be able to influence a consumer’s payment method choice through offers and other incentives, in real time, during the purchasing stream. There’s nothing to stop issuers from trying to shift consumers to using credit instead of debit products and to create enhancements to credit products that make bill payment as easy from the credit card as it is from the online bank account. Some might say that would be too much of a change in behavior for most consumers, but I’m not so sure in a digital world. My hunch is that most people attach a credit card to their digital wallets anyway, given the liability protection that a credit card affords (most people don’t associate using their debit card with unlimited liability). Maybe the ruling actually kicks into a higher gear the move toward mobile payments and digital wallets.
One thing that it will do is cause this dynamic and resilient industry to think creatively about its next moves. A shifting and reshaping of the ecosystem is almost certain. And, speaking of reshaping, try this one on for size. Big banks become outsourced “back offices” for small bank debit products —giving exempt small banks the scale economies of big banks while maybe keeping the high interchange fees, and returning a piece of those interchange fees back to the big banks for the service. Of course, there is no guarantee the exempt banks will continue to get high interchange. The an even bigger spread between the interchange fees for exempt and non-exempt banks merchants, and maybe even the big banks, may drive to lower interchange fees for the small banks too.
What seems to be clear though is that just in the space of the last four or five days, the tides are turning to lessen the dependency on incumbents. If Judge Leon’s ruling sticks, the merchants may have “won” their fight to lower the cost of acceptance of a popular payments product, but their target was the networks that impose the fee, not so much the issuers who receive it, serve the customers and use those fees to support the delivery of debit products. As the boardroom doors close and strategy sessions rev up across the ecosystem, it’s quite likely that many more of the players will become united in who they think strategically they need to beat. And, at the top of that list is probably one four-letter word that I will leave to you to fill in.