Advice to Issuers: Shift from Debit to Credit—And Soon

Hammered by the worst economic downturn in decades, consumers have been abandoning credit cards in droves, instead using debit cards as their plastic of choice. But new research suggests card issuers will soon have to revamp their credit card programs and beef up prepaid card marketing to offset an expected industrywide loss of income on debit card portfolios.

That loss will result from recent regulation, most prominently the Dodd-Frank Wall Street Reform Act of 2010, which includes a provision that gives the Federal Reserve authority to regulate debit card interchange rates for issuers above $10 billion in assets. The legislation, which was signed into law in July and takes effect next year, is widely expected to lead to an across-the-board haircut to interchange rates, severely crimping what is currently a $15 billion annual income flow for banks. Other, earlier regulation requires banks to obtain opt-ins from consumers for overdraft protection, threatening a portion of the overdraft-fee income banks earn on products like debit cards that are linked to checking accounts.

As a result, “debit can no longer be relied upon as a surefire source of strong issuer revenue,” says a research report issued this week by Javelin Strategy & Research, a Pleasanton, Calif.-based firm that follows the payments business. The report, entitled “Payment Card Issuer Strategies 2010,” estimates that as much as $12 billion in debit card interchange and overdraft- fee income could be wiped out by the new regulations.

Complicating matters is that recession-strapped consumers have clearly shown a preference for debit cards. The proportion of consumers actively using credit cards plummeted to 56% last year, down a startling 31 percentage points from 2007 and the lowest number Javelin has ever tracked in its surveys. Unless issuers act, the firm warns, they face a double whammy of withering credit card portfolios and regulatory limits on debit card income. “Issuers simply cannot afford to continue doing business as usual,” the report says. “if events are allowed to continue unchecked, only 45% of consumers will reach for a credit card in 2010.”

Issuers are likely to respond by injecting new life in their credit card programs and also emphasizing reloadable prepaid cards, which are not affected by Dodd-Frank. This will be a tricky proposition, though, given consumers’ historic move away from products that represent debt and unrestrained spending. “To rebuild [credit card] usage, it’s going to take some focus because there’s been a change in consumer behavior,” Beth Robertson, director of payments research at Javelin and author of the report, tells Digital Transactions News.

To meet that problem, issuers will have to market credit cards in a new way, the firm says. This should include high-premium rewards for high-income users, rewards for everyday purchases for everybody else, and features that help cardholders control spending and restore credit ratings. “Credit card marketing needs to promote logical spending among consumers by offering benefits that make credit cards the commonsense payment choice,” the report says.

Whatever banks do to promote credit cards, though, they must avoid their old penchant for penalty-fee income. “Increasing credit card use will be successful only if [the] focus is shifted from penalty fees to [a] positive image,” Javelin says. In part this is because fees late payments and over-the-limit spending will only alienate newly cautious consumers. And in part it’s because yet other legislation–the CARD Act, which took effect Aug. 22–restricts the fees issuers can levy.

Indeed, Robertson cautions, a new regulatory mindset means banks will have to be careful in how they market and price credit cards. “We’re not in the same environment we were in a few years ago,” she says. For one thing, she points out, there’s no guarantee regulators won’t come after credit cards. “If new fees are introduced, it’s like waving a red flag, [saying], ‘hey, come and regulate us next,’” she notes. She also points out that the Dodd-Frank Act created a new consumer-protection agency aimed at financial practices. “Cards are definitely on the radar and will stay on the radar,” she warns.