Debit 101 Lesson 2: Debit Evolution

Durbin Debit 101 (required):  Retail Deposits Have Changed Radically Overnight

Lesson 2 Discussion Board: What is the most likely impact of the Durbin amendment for 1) merchants, 2) financial institutions, and 3) networks? What will change for consumers? Click here to respond.

Lesson 2: Debit Evolution.  In our last class we discussed how consumer spending is driven by real-time anywhere access to deposit funds.  Electronic deposit access executes sales for retailers, drives transactions to the networks that configured the product, and underpins the business model for providing deposit access services at banks.  As we all know, consumer spending is a major driver of the US economy and a key variable in the current economic recovery.  In this session we’ll take a look at how legislative intervention, potentially broad regulation, and oversight by the central bank and a consumer protections board could bring significant change to this complex ecosystem.

Let’s begin with a brief summary of the recent legislation and its potential impact on the industry.  We’ll preface this by freely admitting that PYMNTS University is a business school and not a school of law.  There are legions of people with established legal pedigrees and qualification to debate the potential specific interpretations of the law, how costs will be determined, and how the regulatory oversight of the statute is likely to be implemented.  Over the next month we will see spirited debate in journals like PYMNTS.COM and in the blogosphere over how the amendment will be interpreted.  PYMNTS U encourages all participants to engage in that debate in the chat rooms devoted to this topic and in the discussion area of the course.  (For further reading on the topic, and to review the debate, see the articles and news in the PYMNTS.COM Durbin Briefing Room, found here:

For the purposes of today’s class we will make a few basic assumptions about the interpretation of the law and focus our attention on the possible outcomes of the law and their implications.  The amendment compels the Federal Reserve to engage financial institutions in an analysis of the costs associated with propagating and managing debit card transactions. (For everyone who wants to debate how that fee will be determined, what costs will be reviewed, and so on, let’s talk about it in the discussion area.)  Upon conclusion of that analysis, the Fed will recommend an established rate -an interchange fee or schedule of fees-to govern the exchange between acquirers and issuers of debit card transactions.  Debit cards may not be provisioned exclusively on one network, and acceptors of debit cards may not be restricted from choosing which of the networks available on the card over which they route the transaction.  The legislation also provides for acceptors of debit cards to set minimum and maximum transaction values for acceptance of those products, and it allows for the provision of discounts by payment type.

What does this mean for the business?  Most of the rules changes in the statute are designed to provide for greater flexibility in the way retailers accept debit cards and how they route transactions from those debit cards.  In practical terms, however, most of these provisions – while technically “against the rules” of the debit network operating regulations – were already in place in practical terms.  The statute here essentially codifies liberties with the debit scheme rules for all retail acceptors that major retailers had already taken.

The provision against network exclusivity is also a codification of previous practice – almost all networks provide for incentive schemes, rather than punitive rules, to maximize network participation.  Legal teams within those organizations already saw to that in the way contracts were written.  The wild card in this area is whether or not issuers of debit cards will be compelled to offer multiple network options beyond one PIN and one Signature on debit products. 

It’s difficult to imagine a practical application of a compulsory participation in multiple directly-competitive networks. Imagine the equivalent provision in mobile telephony: a mobile operator provides a consumer with a phone that can make calls over his network and that of all his competitors. The consumer signs up for a plan and value proposition with the operator, but every single call may be routed over a different network at the will of the local cell operator. What happens to his friends and family plan? Anytime minutes? Weekends? Rollover? Voicemail? Texts? Ring tone and application downloads? Good luck with managing that.

Likely Outcome:  So, the major change to the industry here will be in both the level and method of applying interchange fees for debit card transactions.  The most likely outcome of the Fed review and regulatory implementation will be that interchange fees for debit card transactions will be lower on an average basis than they had been previously.  We can all certainly debate how regulation of a financial exchange between banks representing retailers and consumers is a pro-competitive consumer protection.  But suffice to say that the retailers, particularly the largest retailers, will see lower costs of debit acceptance and may or may not pass any of those savings on to consumers.  Smaller retailers will certainly have the opportunity to see the same provision of lower acceptance costs as large retailers, assuming that their acquirers either extend those lower rates on in adjustments to the discount rate they charge or move to interchange-plus pricing that makes the debit rate explicit. 

Debit networks will likely bear the brunt of implementing the fee changes, as they are the most logical concentration point for making those adjustments.  And, while managing higher rates for smaller issuers is technically feasible, it may be business suicide. (Note: Careers in interchange, legal/compliance, and network programming in debit networks should be a major growth area over the coming year).  Financial institutions will see the business case for providing low-cost deposit access significantly challenged, and most will have to radically alter their approach to managing deposit relationships, electronic access, product innovation, service delivery, and —most potentially disruptive— pricing to remain competitive.

In all of this it’s tough to see what improves for our soccer mom just trying to live her life, get gas & food, and get home.  It’s hard to imagine she’ll find it attractive to start carrying wads of cash and a checkbook for these purchases (ever try to stick a check in an automated fuel dispenser?).

In our final class in this section, we’ll focus on how the debit marketplace is likely to evolve in the context of this change, and how the current participants may work to maximize their benefit – or make the best of a tough situation.  See you all in class tomorrow. In the meantime, let’s get to quibbling in the discussion area.

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