Unintended Consequences of Regulation, Part “n”

Unintended Consequences of Regulation, Part “n”

I must admit, I lost count how many times we at Celent have written and talked about unintended consequences of regulation. This is the latest installment.

As most people know, PSD2 has introduced new card multilateral interchange fee (MIF) limits in Europe. Debit card transactions across Europe have been capped at 0.2% of transaction value, while for credit cards, the limit is 0.3%. This is often used as an example of regulators bearing down on the issuers, and in many cases, especially for credit cards, it is indeed a significant reduction of fees charged previously.

However, let's take a closer look at the UK. According to the UK Cards Association statistics, debit card transactions outnumber credit card transactions by 3.3 times (10.3 vs 3.1 billion in 2015), while the purchase value of debit card transactions was greater than that on credit cards by 2.4 times (£439 vs £181 billion in 2015). Furthermore, of nearly 100 milion debit cards issued in the UK, 97% carry Visa brand. In other words, Visa debit cards are the most popular payment cards in the UK.

Visa interchange rates have varied over the years, but immediately prior to March 2015, Visa interchange for consumer debit card chip & PIN transactions in the UK was flat 8p per transaction. In March 2015, those fees changed to 0.2% + 1p, but were capped at 50p. The extra penny could be charged, because the UK Payment System Regulator allowed an interim period where the cap of 0.2% could be applied at an aggregate rather than an individual transaction level. As the individual interchange fees were capped at 50p, that meant that in aggregate they didn't exceed the required 0.2% limit. However, we understand that as of September 1, 2016, Visa UK is removing both the extra 1p and the cap of 50p and setting debit interchange fees at 0.2% per transaction, as required by PSD2.

As the chart below demonstrates, transactions less than £35 become cheaper than 8p set prior to March 2015. At £41.34, which is the latest average debit card transaction value, the current charges are at 9p and new ones post September will be 8p, the same as before. However, transactions above that amount and up to £250 are already more expensive than 8p today and will remain so post September.

MIF1

The real difference is for transactions above £250. The removal of 50p cap and charging at a straight 0.2% means that a £10,000 transaction (for example, when buying a used car) will now cost a merchant £20 in interchange versus the 8p the merchant paid before the regulation came into effect.

MIF2

What about Brexit? Will these European regulations still apply in the future? The answer for domestic transactions is, yes. The interchange caps are now enshrined in the UK regulation and are independent of the UK's status in Europe. More broadly, the Payment Systems Regulator announced immediately following the referendum results that "current payments regulation deriving from the EU will remain applicable until any changes are made, which will be a matter for Government and Parliament." Perhaps a more interesting question is what would happen with transactions between the UK and Europe in the future. If the UK is no longer part of the EU, would the payment networks decide that such transactions should be treated as inter-regional rather than intra-regional? Only time will tell.

So, what are the merchants with larger than average debit card transaction portfolios going to do? In the short term, some might start surcharging to pass the costs on to the customer; longer term, others might start exploring other opportunities presented by PSD2, and consider becoming Payment Initiating Service Providers (PISP) to move customer funds directly from consumer bank account to theirs, shunning cards altogether. Almost inevitably, the most proactive ones will shop around to see which acquirers offer the best deals; remember, these are interchange fees, not the actual merchant charges, and it is up to the acquirers to decide how much they charge their merchants. However, once again, the consequences of a regulation are not quite as originally intended.

Reflections from BAI Payments Connect

Reflections from BAI Payments Connect
Last week I had the pleasure of attending BAI Payments Connect. It is one of those events that has always been on my radar but for one reason or another I never had the opportunity to go. And I was very impressed with it all, particularly with the quality of the conference sessions, which seemed to have been well curated by the organizers. The event was just the right size – not too big to be overwhelming, and not too small. It also had the right balance between “new and shiny”, i.e. things that will matter tomorrow and “down to earth”, i.e. issues that matter today. With four parallel tracks, there was no way to attend all the sessions. As a result, I didn’t attend too many sessions in the fraud or payments operations & check image tracks. So below is definitely not a full summary of the conference, but just a few of my personal key takeaways:
  • Real-time payments are firmly agenda for the US. There is still much debate about what ‘real-time’ really means and what is the best way to achieve it, as indicated by Bob Meara’s blog about the same-day ACH initiative. At the conference the Fed representatives shared the results of the public consultation on payments system improvement. The Fed received about 200 responses. More than three quarters of respondents agreed that ubiquitous participation, confirmation of good funds and both speedy payment settlement and delivery of information would be important. However, many also suggested that near real-time confirmation of good funds and notification are more important than near real-time posting to end-user accounts and interbank settlement. And opinions certainly were divided on how to achieve near real-time delivery of payments. Some advocated limiting any future faster payment options to credit (push) payments to help prevent fraud. The Fed is going to work on defining and prioritizing the US payment system improvement initiatives and expects to communicate these plans in a paper to be published in the second half of 2014.
  • PIN debit networks are continuing to promote PIN-less debit transactions, including at the POS. Visa and MasterCard implemented signature-less transactions at merchants a few years back and raised the limit to $50 in 2012. PIN debit networks responded by also allowing PIN-less routing for transactions under $50. PIN networks tend to have lower interchange rates, but also lower overall fees to stay competitive for the issuers. Nevertheless, it was intriguing to hear one credit union CFO saying that their revenue per transaction declined from 114bps to 94bps. While some of the decline can be attributed to a rising share of PIN-less debit transactions, another reason is PayPal. Having managed to convince a large number of customers to register their bank account as a funding source, PayPal now tops the ACH transactions, above billing, for that particular credit union. Which is related to the next point below…
  • Decoupled debit is not dead. While some decoupled debit initiatives, most notably Tempo, have disappeared off the market, PayPal and ACH cards, such as Target Red, are arguably very similar products. With retailer-led mobile initiatives coming into play, such as MCX, “decoupled debit”, i.e. replacing a card transaction with direct debit on a bank account, may have a meaningful impact on the growth of card transactions.
  • Bitcoin: forget the currency, focus on technology. This is the same message I already highlighted in my recent report on Top Retail Payment Trends, but was reinforced again in a hugely informative and entertaining presentation at the conference. Blockchain, a distributed open public ledger with appropriate cryptography, could be used to prevent “double spending” of any digital asset, not just money.
I also wanted to thank the organizers for the opportunity to share the stage with executives from Bank of America and Cardlytics. I had the privilege to interview them about BankAmeriDeals, Bank of America’s card-linked offers program. There is certainly a lot of interest in card-linked offers in the US banking community. In fact, the audience made my job very easy; after a few introductory questions and comments, they had so many questions that we could have easily spent another hour discussing them. Finally, such events are always a good place to meet up with existing and potential clients and I had a number of very interesting discussions with them. Vegas is a long way from London, but it was a worthwhile trip.

“Should We Repel Durbin?”

“Should We Repel Durbin?”
That was the question someone asked me last week at an ATM, Debit and Prepaid Forum. I know – it was in Vegas, the person was joking and the question is really a rethorical one. And yet, it kind of rings true, because no one seems to be happy with the new regulation. Except, of course, the lobbyists, lawyers and other industry advisors. And perhaps some acquirers and ISOs. As expected, “Life after Durbin” discussions dominated the event. Of course, the large debit issuers are unhappy – the general consensus is that this will wipe out about $8bn in annual interchange revenue for the industry. The issuers are looking for ways to cut costs or to raise revenue. It was interesting to watch how nearly everyone had to update their slides, as Bank of America withdrew their planned $5 debit card fee about 24 hours before the official conference started. The bank itself explained that they “listened to the customer feedback and acted accordingly.” The smaller exempt issuers are not entirely unhappy. Credit unions announced a large new customer intake (“760k new accounts in the last 10 days, more than in the entire year previously”). However, they are worried that they will also feel competitive pressure on interchange or might be discriminated by the merchants and their acquirers. Also, it remains to be seen how profitable the new customers will be for them. Prepaid issuers seem to be unsure what to make of it. On one hand, some prepaid cards are exempt from regulation, however, the exemption conditions and small print gets very complex very quickly. Cue in the lawyers and corporate counsels to help navigate the regulatory maze. The network routing rules banning the exclusivity arrangements are seen as an opportunity by at least some of the networks, especially the smaller ones. However, the implementation – renegotiation of contracts, setting up of routing rules, etc – is not an insignificant undertaking for all involved. Cue in consultants and more lawyers. Perhaps most surprisingly, the merchants are not happy at all. The merchant panel, represented by senior executives from Walmart, 7-Eleven and McDonald’s was one of the most interesting sessions at the Forum. They all expressed disappointment in the final regulation. Walmart said that the regulation was a “disappointment, but a good start for future regulatory reforms, including credit.” It is true that for small ticket purchases, the costs of debit acceptance have gone up, as it’s now a flat fee, i.e. the cap was implemented also as a floor. When asked if and when consumers can expect to see lower prices, the merchants responded by saying that the “merchant market is very competitive, therefore any cost changes will be passed to consumers, both increases and decreases”. In other words, “expect prices not to change much or perhaps even go up.” Redbox, a US-based DVD rental firm, already followed through on this and raised its prices for DVD rentals from $1 to $1.20 quoting increases in their costs of debit processing. Smaller merchants are also unhappy because it might take time for any savings to trickle through to them. Unless their acquirers and processors charge them “interchange plus”, they may find it difficult to demand immediate reductions in their bundled fees. Those with lower volumes may also lack the necessary know-how or may simply prefer avoiding the hassle of putting pressure on their acquirers to lower their fees. It will take a better part of next year for the full effects of Durbin regulations to become clearer, but the early signs are that it won’t reach all of its intended outcomes. So, what’s next? P.S. As an aside, this year’s ATM, Debit and Prepaid Forum saw the best-ever attendance – over 1,100 participants – and had a very interesting agenda with great speakers. Congratulations and thank you to SourceMedia, the event organisers, and Tony Hayes, a conference chairman (and a partner at Oliver Wyman, Celent’s parent company) for all their efforts!

Durbin D-Day

Durbin D-Day
Finally, the wait is over. Yesterday (June 29th), the Fed’s Board approved and announced the final version of Regulation II, known in the payments industry as the Durbin amendment, which sets out the rules for debit card transactions. Financial institutions feared the worst after the initial proposals annouced in December last year. Today, banks can breath a sigh of relief. In both of the major issues on the table – the interchange caps and the rules for network exclusivity – the Fed’s final rule is better than the proposed worst-case scenario. Visa’s stock closed the day at $86.57, up by $11.29 or 15%. For the interchange, the Fed settled on a cap of 21 cents on transactions that fall within the regulation’s scope. Furthermore, the banks can charge an additional 0.05% of each transaction’s value. Finally, another 1c could be added if the banks’ fraud-prevention systems were deemed adequate by the Fed. Given this, an issuer still needs a $100 transaction to break-even based on the issuer’s average transaction cost of $0.27, which was outlined in the Industry’s comment letter to the Fed during the consultation period. However, it is a significant improvement over the originally proposed cap of 0.12c per transaction. For network exclusivity, the Fed opted for Alternative A, i.e. the issuers will have to place two unaffiliated marks on every debit card, which is most likely to translate into one signature and one PIN network. Again, this is not as drastic a change as it would have been under Alternative B, which would have demanded two network choices for each method of payment (i.e. two signature and two PIN). Even though the final rules are not as harsh as the worst-case proposals, the financial industry is still worse-off and will have to adapt. The retailers should be declaring victory, however, instead, The National Retail Federation expressed “serious disappointment” and called the final rules “a major loss for American consumers.” The new rules will go into effect on 1 October, 2011. The cloud of uncertainty has been lifted and the industry can get on with final preparations and implementation. The numbers can be plugged into the scenario models built up by various institutions over the last year to finalise the expectations of impact, the relevant systems can be upgraded accordingly and the contract negotiations (e.g. around network affiliations) can proceed with certainty. Of course, as we all continue to study the final rules, more questions will emerge. And, as the dust settles, there will be unexpected outcomes and consequences of this momentous ruling. But this morning, the US financial institutions should reflect that it could have been a lot worse.

Replacing debit interchange with a new fee?

Replacing debit interchange with a new fee?
Over the weekend I read an open letter by Senator Durbin to JP Morgan Chase CEO Jamie Dimon regarding interchange fees. In the letter Senator Durbin sets outs his arguments for why the Senate was compelled to introduce debit interchange regulation, which overall makes a very interesting reading. One paragraph especially caught my eye (my Bold Italics highlighting): “Last year Congress decided that there should be reasonable regulatory constraints placed on Visa and MasterCard to ensure that they cannot use their market dominance to funnel excessive interchange fees to the nation’s biggest banks. A strong bipartisan majority supported my amendment, which said that if Visa and MasterCard are going to fix fee rates on behalf of banks with over $10 billion in assets, those rates must be reasonable and proportional to the cost of processing the transaction. It is important to make clear that if Chase wants to set and charge its own fees in a competitive market environment, the amendment does not regulate those fees. The only regulated fees are those fees that banks let card networks fix on their behalf.” This got me thinking… does this mean that the issuers are free to introduce a new fee, which they could charge the acquirers in lieu of interchange, lets say an “authorisation” fee? Of course, any issuer who goes first faces to be at a competitive disadvantage to others, at least initially. The industry players don’t have to collude to raise prices with various signalling techniques available to them and given the market clout of the largest issuers. I am sure there would be other challenges (e.g. technical, etc.), but is this completely out of the question? Why? What do you think?