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On July 21, 2010, a small but significant piece of legislation known as Amendment 3989 to the Restoring American Financial Stability Act of 2010, became law. All of the players in the prepaid card-issuing value chain must act quickly to identify the changes this legislation may trigger and turn them into valuable market opportunities.
Amendment 3989, also called the Durbin Amendment, was proposed to lower interchange costs for small businesses. Part of the amendment directs the Federal Reserve to issue rules to ensure that debit interchange fees are “reasonable and proportional” to the processing costs incurred. A fact sheet put out by Sen. Dick Durbin (D-Ill.), who proposed the amendment, compares this part of the amendment to the “reasonable and proportional” standard that Congress directed the Fed to use to oversee consumer credit card fees in the 2009 Credit Card Accountability Responsibility and Disclosure (CARD) Act.
Banks and credit unions with assets under $10 billion are exempt from this requirement. On one hand, this cap is interesting because the two largest prepaid card issuers have less than $10 billion in assets. On the other hand, many close observers contend the cap is irrelevant because it is negated by other provisions of the amendment. A conference committee compromise on the bill added exemptions for government benefits prepaid cards as well as reloadable prepaid cards such as payroll and GPR. Despite the fact that prepaid has dodged this bullet, the amendment is still relevant for players in the prepaid card-issuing value chain because it will create a ripple effect throughout card issuing that will influence the prepaid landscape. The amendment also prevents card networks, such as Visa and MasterCard, from penalizing merchants for offering discounts to customers who use competing card networks and for customers who pay by cash, check or debit card.
The most obvious outcome of this legislation is that by limiting interchange fees, financial institutions will earn less interchange revenue. Prepaid players should be aware that this might spell an end to free debit cards, particularly for lower-balance customers. Banks may not offer less profitable customers a free debit card if they are earning less income from those customers, who already incur higher charge-offs and lower revenue. For lower-income customers who now rely on the convenience of a free debit card, prepaid cards may be the only branded card option. This would be a boost to the prepaid card industry for two reasons. First, more consumers would be drawn to prepaid card products. And second, banks might be more likely to issue prepaid cards alongside traditional debit to take advantage of the exemption and to hold on to customers. Financial institutions that offer both debit and prepaid cards will be able to lower risk and still collect interchange fees from prepaid cards used in place of debit cards. Those that don’t offer prepaid cards stand to lose customers who must shift to prepaid cards.
You can expect the Durbin Amendment will prompt the card networks to implement the same kind of segmentation for debit interchange that we currently have for credit interchange. This will not be fun for an acquirer to implement. Some speculate that acquirers will go to “flat” rates that will be higher in order to cover all costs incurred by complicated interchange rates.
Today, debit has only two categories: consumer debit and commercial debit for B2B transactions. To overcome limitations on interchange fees, new categories of interchange fees will likely emerge such as debit reward and “signature” debit (akin to signature credit products).
As debit interchange segmentation follows the way of credit interchange, we can expect that a low feature “classic” credit card and a high-end debit reward card will earn similar interchange. As the credit/ debit interchange gap continues to narrow, we may see higher credit interchange fees. Because of the carve out, it will have to be that prepaid will have its own interchange category. Therefore, debit interchange segmentation surely will complicate operations and increase costs for acquirers that implement the tiered debit interchange rates by merchant category and card type.
Ironically, it seems the Durbin Amendment is unlikely to make a direct and immediately positive difference to the two groups it was designed to help: retailers and consumers. It does, however, present interesting opportunities for retailers that are able to take advantage of the new interchange structure Durbin likely will create.
The average consumer is unlikely to notice any changes caused by the Durbin Amendment because merchants are unlikely to lower their prices as a result of paying less interchange. In addition, the legislation will not make more debit cards available to more people. Quite possibly, it could do just the opposite as issuers work to lower costs by lowering risk.
Lori Breitzke is founder and president of E&S Consulting, a payments industry consultancy that advises merchant acquirers, retailers, card marketers and issuers in a broad range of payment and financial services domains including prepaid program management, competitive research, training, marketing, POS hardware and software management and partner recommendations.
E&S Consulting Website: http://www.eandsconsultingllc.com/articlespresentations.php