How Prepaid Cards Could Help Issuers Recover Some Income Lost to Durbin

As debit card issuers move to impose new fees or trim back rewards in response to looming federal restrictions on interchange income, they may be ignoring an opportunity to recover as much as half of that interchange without levying a single new fee.

That’s according to research released this week by Boston-based Aite Group LLC, which argues that issuers could get back a significant chunk of interchange income by inducing customers to move from debit cards to prepaid cards. They could recover even more by promoting a mix of prepaid and credit cards, the study says. While the Federal Reserve is working out rules to implement the Dodd-Frank Act’s Durbin Amendment, that law regulates only debit card interchange, leaving reloadable prepaid and credit cards alone. Durbin applies only to banks with $10 billion or more in assets.

The Fed’s final rules were expected next month, but a bipartisan group of senators recently introduced a bill to delay Durbin rulemaking for two years to allow for more study of the issue. The Fed in December proposed a set of rules that would cut debit interchange from what it found to be an average of 44 cents per transaction to a cap of 12 cents, a hefty 73%  reduction that has many banks crying foul and looking at a range of actions to make up the lost income, including new account fees and higher hurdles for frequent-flier miles and other rewards.

But the Aite study, authored by analyst Ron Shevlin, suggests big issuers could earn back anywhere from 4% to 51% of the debit interchange they currently take in by encouraging cardholders to switch either to prepaid cards alone or to a mix of prepaid and credit cards. “Importantly, this recouped revenue would come strictly from interchange—not from any additional fees levied on bank customers,” says Shevlin in the report.

In one scenario suggested by the report, a hypothetical issuer with 500,000 cardholders could recover 20% of pre-Durbin revenue by inducing 15% of transaction activity by what the report calls moderate and high transactors to move to prepaid cards. In this scenario, the bank would see interchange per customer grow from $17 to $26 for high-transactor prepaid users and from $6 to $8 for moderate-transactor prepaid users. The report defines high transactors as those who perform more than four card transactions per week. Moderate transactors do one to four weekly card transactions. An Aite survey indicates 20% of consumers are high transactors, while 43% fall into the moderate-transactor group.

Under the most optimistic scenario, Aite suggests issuers could recover slightly more than half of pre-Durbin income by inducing 20% of activity by high and moderate transactors to move to prepaid cards, while at the same time pushing credit card usage as well.

Shevlin says in the report that, while prepaid cards are still viewed by many banks as a product for the unbanked, a migration by mainstream customers to prepaid has become a practical expectation.  He argues prepaid use is “increasingly prevalent among Gen Xers and Gen Yers.” Aite’s survey shows 26% of Gen Y respondents had used a debit card at least once in the fourth quarter last year, along with 23% of Gen Xers. The corresponding numbers for Baby Boomers and seniors were 13% and 3%. “The notion—held by many within the industry—that prepaid cards are for economically disadvantaged, underbanked consumers is outdated,” Shevlin says in the report.

To act on the opportunity to recoup debit income lost to Durbin, Aite recommends issuers take such steps as bundling prepaid cards, but not debit cards, with checking-account products.