Trends & Tactics: The Fed Lets Its Durbin Regs Stand

As they began their work, some Federal Reserve Board governors expressed uneasiness with the task Congress assigned them in 2010 through the Dodd-Frank Act: implement the debit card regulations called for in the sweeping law’s Durbin Amendment.

In March, however, the Fed expressed enough satisfaction with its handiwork to declare that it does not plan to propose changes to its controversial rules, at least for now.

Dodd-Frank requires the Fed to report on the debit card market every two years, and the March report is the second such effort. The report is based on a survey of 15 card networks and 131 debit issuers early last year and covers calendar year 2011. The Fed’s first report, which formed the basis of its Durbin regulations, looked at debit card costs and revenues for 2009.

The new report created a fresh opportunity for opponents in the highly partisan interchange fight to take more potshots at each other—and the Fed. The Retail Industry Leaders Association blasted the Fed for permitting some of the biggest regulated debit card issuers, those with $10 billion or more in assets, to still collect nearly five times their average cost for authorizing and settling a debit transaction despite the Fed’s price controls that took effect Oct. 1, 2011. And the Electronic Payments Coalition (EPC) representing card networks and banks once again criticized merchants for allegedly not passing on their reduced debit card acceptance expenses to consumers.

The price controls set a per-transaction cap of 21 cents plus 0.05% of the sale in addition to another penny if the issuer takes fraud-prevention measures. That cap cut regulated issuers’ debit revenue by 52%, but still was much higher than the Fed’s original proposal of a 7-to-12-cent cap.

The new report says issuers’ expenses for the authorization, clearing and settlement (ACS) of debit card transactions varied widely in 2011. The median issuer’s average ACS expense was 11 cents, but the costs of the biggest issuers, who dominate the debit market, were only 5 cents. Issuers at the 75th percentile had an average cost of 36 cents per transaction.

In standing pat, the Fed said 67% of regulated issuers had average ACS costs below 21 cents in 2011. While the proportion was lower than the 80% of covered issuers with average ACS costs below 21 cents in 2009, the Fed attributed the change to the addition of first-time survey respondents, most of whom were foreign banks or other regulated issuers with very small debit card programs and high ACS costs. Issuers that responded to both the 2009 and 2011 surveys typically reported ACS costs were lower in 2011 than in 2009, the Fed said.

The Fed also estimated that debit card fraud losses to all parties (merchants, cardholders, and issuers) totaled $1.38 billion in 2011, with an average loss of approximately 8 basis points per debit card transaction, down slightly from 2009.

The EPC noted the Fed found that small banks’ and credit unions’ debit card interchange revenue has begun to decline despite their exemption from the Durbin Amendment’s price controls. The report says the average per-transaction interchange fee received by exempt issuers slipped 4% in 2011, from 45 cents to 43 cents.

That was before before the Durbin Amendment’s so-called network-exclusivity and transaction-routing provisions kicked in on April 1, 2012. Those provisions, which gave merchants more freedom to route debit transactions to the networks of their choice, affect all issuers and are likely to reduce exempt issuers’ interchange revenue even more.

The Odds Shift in Online Gambling’s Favor

With New Jersey in late February becoming the third state to legalize online gambling, the market for the first time in years has begun to offer possibilities to merchant acquirers as a promising new source of transaction volume. But questions remain about how and how soon the new state laws will be implemented in practice and about how willing processors and banks will be to handle online-gaming transactions.

Home of a major casino industry, New Jersey followed Nevada and Delaware when its governor, Chris Christie, signed into law legislation allowing gaming Web sites to take bets from persons who are physically located in the state. The Garden State thus becomes the most populous state so far to approve online betting. Actual wagers, however, are not expected until later in the year.

The move by these states toward legal but regulated online gambling follows years of efforts by state and federal governments to quash the business. Perhaps the most far-reaching of these efforts was the passage in 2006 of the federal Unlawful Internet Gambling Enforcement Act, which banned banks and processors from handling online-gaming transactions. That law drove online-wager processing offshore and forced a number of U.S. acquirers to quit the business.

“When UIGEA came in, we were doing a lot of online gambling,” recalls Richard W. Noble, chief executive of BCC Merchant Solutions, a North Kansas City, Mo.-based independent sales organization. “I’d love to do it again.”

A major turning point came in December 2011, when the U.S. Department of Justice released a memo in which the agency interpreted the 1961 Wire Act to apply only to online sports betting. This interpretation, which came in response to states looking to sell lottery tickets online, appeared to clear the way for online poker and other games, as well.

“President Barack Obama’s administration has just declared, perhaps unintentionally, that almost every form of intra-state Internet gambling is legal under federal law, and so may be games played interstate and even internationally … I believe this will be a major incentive for the other states looking at legalizing intra-state poker and other games,” said I. Nelson Rose at the time the Justice memo came out. Rose is a professor of law at Whittier Law School, Costa Mesa, Calif., and a nationally recognized expert on online gambling law.

Still, it may require the repeal of the UIGEA to induce acquiring banks and processors to enter the market, says Noble.

“Banks are not geared to look at laws, they’re geared to find a law and run away from it,” he says. “If there’s a risk of noncompliance, a bank will leave it alone.”

A slow response by banks and processors to state legalization could hinder the market’s development for some time. It also remains unclear how far the legalization trend will go. It is unlikely all states will eventually follow in New Jersey’s footsteps. Plus, leveraging the full potential of state legalization will require agreements, or so-called compacts, between states to allow residents of one state to place bets in another, much as multi-state compacts now create bigger payoffs for lotteries.

But Noble remains optimistic.

“I’d imagine within a year or so we’ll see [online] gaming come back,” he says. “I would not be a bit surprised to see the UIGEA repealed.” This would be particularly likely, he adds, as soon as state and federal governments “figure out how to tax” online-betting activity.

Whither Acquirers? Probably Not

The new Chase Merchant Services (CMS) processing entity announced Feb. 26 by JPMorgan Chase & Co. and Visa Inc. triggered plenty of chatter in merchant-acquiring circles about whether CMS represents a threat to the traditional bank card payments model.

CMS certainly is a different animal in that its business model would seem to enable more direct links between card issuers and merchants. And some observers wondered if CMS revealed aspirations by Visa to become a direct acquirer.

JPMorgan Chase is the nation’s leading credit card issuer and one of the top debit card issuers, and it also owns No. 2 merchant processor Chase Paymentech. The bank is licensing a version of Visa’s VisaNet network in order to offer its merchants, through CMS, favorable pricing and its cardholders cash discounts or other perks when they use their Chase Visa cards at Chase merchants.

“It’s funny this came up, because this is exactly the way the world is going,” says Henry Helgeson, chief executive of the big Boston-based independent sales organization Merchant Warehouse. “How do we do more with a card than just the payment?”

Merchant Warehouse has been rolling out what it calls its Genius platform that handles multiple payment types and aims to drive traffic to the ISO’s merchants through promotions and loyalty programs.

By using CMS to create more or less of a direct link between its issuing and merchant sides, Chase could upend the traditional “four-party” model of bank card payments that encompasses the cardholder, card issuer, merchant acquirer and merchant.

“The writing’s on the wall for acquirers,” says industry consultant Steve Mott, principal of Stamford, Conn.-based BetterBuyDesign. “Acquiring is a millstone from a prior era. You don’t need the four-party model anymore.”

That may be a bit of a stretch; even Mott says acquirers will be needed for “merchant boarding and underwriting.” But beyond those core functions, CMS could represent a future in which the acquirer’s traditional role is reduced.

But many details about CMS remain unknown. What Chase, which under chief executive Jamie Dimon has taken a do-it-yourself approach to technology, gets out of the deal seems clear. That is, more freedom to set merchant pricing and control over operating rules in exchange for paying Visa a certain amount of money, and an opportunity to forge closer ties between its cardholders and merchants.

A major question CMS raises is if the model could be exported to other card issuers, particularly if they don’t have acquiring operations. Some observers say the most natural candidate for a similar deal would be Minneapolis-based U.S. Bancorp, which is a sizable credit and debit card issuer and has a big acquiring subsidiary, Elavon, which uses its own technology platform. Other possibilities include Bank of America Corp. and Wells Fargo & Co., both very large card issuers. They also have major acquiring operations, but they rely heavily on processor First Data Corp., as do many smaller acquirers, which could complicate matters.

“Anybody else that’s meaningful [beyond U.S. Bank,] you’ve got to do a deal with First Data,” says consultant Eric Grover, principal of Minden, Nev.-based Intrepid Ventures.

Meanwhile, one acquiring-industry researcher dismisses fears that Visa might be trying to get into direct acquiring—a fear that periodically washes through the industry.

“Though the temptation will always exist to label the card network as the ultimate threat to the existing merchant-acquiring business, Visa has proven time after time it intends to be ‘Switzerland’ indefinitely,” David Fish, an analyst at Maynard, Mass.-based Mercator Advisory Group Inc., wrote in a recent blog post.

Fish sees CMS as fundamentally “a technology play” with the potential to deliver valuable services to both merchants and consumers, not a revolutionary change in the acquiring industry’s operational structure.

Helgeson adds that Visa is responding to the changing realities of its industry.

“Visa knows that they have to offer more than payments,” he says. “Any time you’re creating value, you’re creating revenue opportunities. For them it is as much defensive as it is offensive.”

Credit Cards: 2013’s Comeback Kids

After taking a beating in the recession, credit cards began an unsteady recovery in 2010 and 2011. Now, reports from First Data Corp. and Visa Inc. indicate credit card charge volume is nearly back to full health.

In a mid-March investor presentation, Visa reported that U.S. credit card payment volume increased 11% from Jan. 1 through Feb. 28 over the same timespan in 2012. The leading payment network also said that debit volume decreased 3%. Visa did not disclose actual volume or transaction figures.

Meanwhile, the most recent SpendTrend report compiled by First Data Corp., the biggest payment processor, shows that charge volume on credit cards grew at more than triple the rate of debit cards in February. Credit’s growth was down a bit from January, but still far ahead of debit cards.

Credit card usage often trails changes in the wider economy, which of late is showing strength after a long period of near dormancy.

“I think it is just because we’re seeing this turnaround in consumer confidence, primarily,” says Beth Robertson, director of payments research at Pleasanton, Calif.-based Javelin Strategy and Research, now a part of Greenwich Associates.

Robertson says the Visa and First Data numbers confirm what Javelin found in an October survey of consumers’ payment preferences at the point of sale. A report about the survey, which asked more than 3,200 consumers about their use of credit and debit cards as well as checks and cash, will be out soon.

In the recession, many card issuers severely reined in their loss-wracked portfolios by closing risky accounts, trimming credit lines, and scaling back their account-acquisition efforts. Now they’re relaxing a bit.

“We’re seeing some loosening of the standards in that consumers who were turned down for credit a few years ago are getting it today,” says Robertson. Regarding credit limits, she adds: “We’re seeing them raised.”

Another factor playing an undetermined role in credit’s revival is the Durbin Amendment in 2010’s Dodd-Frank Act, which cut the interchange income of big debit card issuers by about 50%. Some banks responded by encouraging customers to switch purchases to credit cards, Robertson says. The Durbin Amendment also caused a massive switch in volume away from Visa’s Interlink PIN-debit network, although Visa says its signature debit card business is still growing.

In its analysis of February’s charge volumes, First Data noted that total dollar-volume growth slowed to 4.6% from 6.2% in January. Higher payroll taxes, a delay in federal tax refunds, high gasoline prices and nasty winter weather restrained spending, the processor said.

First Data also waved a caution flag at credit cards.

“The fact that the personal savings rate significantly declined in January and consumers shifted more spending onto credit cards could be a sign that consumers may be overstretched,” Rikard Bandebo, vice president and economist at First Data, said in a statement. “However, there are many other factors that could impact spending going forward including an improving labor market, steadily rising home values, healthy gains in the equity markets and the federal budget sequestration.”

Other data indicate that Americans aren’t getting intoxicated again on plastic credit. The Federal Reserve Bank of New York recently reported that credit card balances stood at $679 billion as of Dec. 31, down 3.6% from $704 billion at the end of 2011 and up less than 1% from their level in 2012’s third quarter.