Santa Fed Puts a Smile on the Faces of Merchants

On the tenth day of Christmas millions of merchants got a proposal from Santa Fed Claus to cut the fees they pay debit card issuers by as much as 84%, putting up to $13.6 billion in their pocket and a smile as big as boy getting his first Xbox on their faces.  Meanwhile thousands of banks found notes from Santa Fed telling them to kiss their debit card profits good-bye for now. Of course, we’re not really counting the days of Christmas very well. Santa, in fact, came down the chimney on December 16, around mid-afternoon, and looked an awful lot like Ben Bernanke.  Or was that Dick Durbin deciding who was naughty and nice?

Seriously, folks, the Fed proposal last Thursday, if it or anything close to it becomes the rule of the land, will lead to radical changes in how the payment card industry does business. Everything from how card products are priced, how merchants are serviced, and what kinds of innovations are considered will change.  It has to because Santa’s announcement kills the business model for cards—at least debit cards—that the industry has relied on forever.”¨ (Related Article: Debit Card Interchange Fees Plummet Under Fed’s Proposed Rules)

Merchants have always carried most of the cost of offering card programs to consumers. Starting in the early part of the twentieth century, merchants offered their own charge programs based on cards and paid the entire cost.  In 1950, Diners Club introduced the first successful card that consumers could use at many unaffiliated merchants.  Merchants flocked to the card even though they had to pay 7 percent of the transaction to the card company.  Consumers, meanwhile, paid little after their free float was taken into account.  Other three-party card networks such as American Express entered the market using the same merchant-pays model. Soon, four-party networks, including MasterCard and Visa, followed suit. In their case they relied on the interchange fee to charge the merchant for some of the costs of issuing cards.  Merchants gradually reduced their own card programs and agreed to take cards.  This same story played out in just about every other country in the world. Merchants ended up paying much of the cost of providing charge, credit, and debit cards to consumers for the convenience of paying at the merchant (consumers revolvers of course also paid in the case of credit).  The merchant pays business model for cards had a better than century long run.

The Federal Reserve Board proposal, which implements Section 1075 of the Dodd-Frank Wall Street and Consumer Protection Reform Act, would kill that business model for debit cards—or almost anything that takes payments directly out of any checking or savings account that a consumer has.  The Fed proposal doesn’t touch credit cards but no one who makes their living from those cards should sleep well this holiday season either. The Fed has become the price regulator for the card industry.  Remarkably, it has already suggested that it may be able to regulate the merchant fees charged by three-party systems on the grounds that these fees implicitly include compensation for issuing much like the interchange fees. 

With much of the revenue and profit sucked out of debit cards, the industry will have to invent a new business model.   Almost everything is on the table as the industry recreates itself.  That means charging fees to consumers and deciding what sorts of cards consumers are offered (with or without those fees).  Banks will be venturing into unchartered territory here.  To navigate the treacherous waters they need to figure out how consumers will react to new products and fees and also anticipate what rival card issuers will be doing (while staying in the good graces of the Consumer Financial Protection Bureau).  The payments industry will also need to redefine its relationship to the merchants.  Merchants pine for creative payment solutions and ways to bring consumers in the door. The industry will be figuring out ways to tap into those desires to make money while doing it. (Related Article: Dodd-Frank Chief Author Opposed to Feds Initial Debit Proposal)

The direction of innovation will also change.  Santa probably all but decimated alternative payment methods that depended on charging merchants lower fees.   Moreover, between the Fed as price regulator and the Consumer Financial Protection Bureau housed in the Fed now deciding what financial services products are naughty or nice, all investments in the payments industry have become much more uncertain and risky.  Innovation will need to move to areas that are less likely to be touched by the regulators.

If you like sitting in the payments industry equivalent of an easy chair and living the calm life, this will not be a very good Christmas for you.  You got the proverbial lump of coal, and a massive one at that. For anyone who loves adventure, the adrenaline from riding the rapids and not knowing where the rocks and waterfalls may be, and skirting death at every turn, Santa Fed provided a wonderful Christmas present. (Related Article: Durbin Webinar: Analysis of the Fed’s Draft Debit Card Regulation)


Twelve Days of Christmas



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  3. Will 2011 Be The Year of the Opt-In?

  5. Is 2011 the Year for Social Commerce?

  7. New Global Payment Schemes: Imitation, the Sincerest Form of Flattery?

  9. Small (Biz) Is Beautiful and Plentiful (for Paying and Borrowing)

  11. Who Will Process My eCommerce Payments Now?

  13. Wheeling and Dealing Through 2011

  15. All I Want for Christmas is my NFC?

  17. Point of Sale Revolution: Transformation of Payment Acceptance