January 13, 2011
In the wake of the Federal Reserve Board’s proposed interchange caps for debit cards, as well as Visa Inc.’s decision to introduce dual interchange tables for debit, much discussion has focused on the impact of radically reduced interchange income on issuing banks. But an often overlooked factor concerns just how much of this reduction will flow through to merchants, and then, by extension, to consumers. The answer, it appears, is not necessarily all of it, and not necessarily right away. And bigger merchants could well benefit more than smaller ones.
The question of savings for merchants and consumers is critical because it was a key selling point for the Durbin Amendment, which was part of the Dodd-Frank Act signed into law in July by President Obama. Sen. Richard Durbin of Illinois championed the amendment in part as a means of controlling costs for merchants and benefiting consumers. Not surprisingly, most merchants favored the legislation, and merchant trade groups lobbied heavily for it (as banking lobbies lobbied against it).
The Fed, charged by the legislation with implementing debit-interchange cuts, stunned the industry last month with a proposal that would cap pricing at either 12 or 7 cents per transaction, a reduction of more than 70% on average. Comments to the Fed are due by Feb. 22, and final rules are due by April. With the legislation exempting institutions with less than $10 billion in assets from pricing regulation, Visa last week said it will support separate interchange schedules, with an unregulated table applying to transactions on cards from smaller banks.
But in the payment card systems, acquirers pay interchange to issuers and then pass it along as a cost to merchant clients. In theory, at least, independent sales organizations and other such middlemen could pass on some, all, or none of the reduced interchange to merchants. Whatever they did not pass on they could simply pocket for themselves. This nuance in the law and proposed regulations has not been lost on acquirers. “In short, it could be a windfall for some ISOs, depending on how they price their merchants,” observes Henry Helgeson, co-chief executive of Merchant Warehouse, a 13-year-old Boston-based ISO.
Helgeson and others point out that, while most big-box and other major merchants receive so-called interchange-plus pricing that makes interchange costs transparent, most small merchants are on so-called tiered pricing plans that can obscure interchange costs as well as changes in those costs. With tiered pricing, acquirers blend what are often a complicated congeries of rates set by the card networks, along with their own markups, and group them into several tiers depending on factors such as volume. An ISO could have about half of its volume on tiered pricing in many instances.
How much ISOs will retain, and how long their advantage will last, are big unknowns. The benefit for any given acquirer also depends on the proportion of its volume that comes from debit cards. Often, this is at least 40%, according to industry sources. A top executive with a major ISO who preferred not to be named told Digital Transactions magazine last month that he would be “shocked” if any acquirer with a typical mix of debit and tiered-pricing volume passed on more than a quarter of the Durbin savings to merchant clients.
Helgeson argues ISOs will likely retain some of the savings, if only to compensate for merchant attrition and acquisition costs. Competitive forces, he says, will quickly erode any large Durbin margin, since rival ISOs can be expected to aggressively court merchants. These competitors are likely to explain the Durbin regulation to merchants and help them check their statements to see if they are getting the reduction they should be getting from their current provider. “What ISOs can’t do is pretend this isn’t going to be a problem,” notes Helgeson. “This is going to get competitive.”
At the same time, all merchants on interchange-plus pricing plans will simply see an automatic reduction. While Helgeson won’t say how much of Merchant Warehouse’s volume is priced as interchange-plus, he says the percentage is up “significantly” compared to two or three years ago.
The upshot? “I don’t know how long we’ll be able to hold on to those margins,” Helgeson says, but he predicts it won’t be long. “You’ll see a decline almost immediately,” he says. Then it will only be a question of how long it will take rates to find a bottom, and at what level that bottom will settle.
As for consumers, Helgeson doubts they will see much benefit. Even if merchants pass on their Durbin savings to them, he says, many will see banking costs, such as fees for checking accounts, go up as issuers seek to compensate for lost interchange revenue.
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