Durbin Will Hurt, But It’s No Apocalypse for Debit, McKinsey Expert Says

There may be some good news for large banks and card networks fretting over the looming effective date for the Durbin Amendment and its restrictions on debit card income. While the amendment, part of the Dodd-Frank Wall Street reform legislation signed into law last summer, will severely compress debit card interchange revenue for issuers with more than $10 billion in assets, the impact on the debit card business won’t be the disaster some banks and network officials are fearing, according to David Stewart, senior expert at the consulting firm McKinsey & Co.

“We don’t see debit falling off a cliff,” Stewart told the audience at a payments conference on Monday. “Net-net, we think there’ll be a slowdown in debit [growth], but it’s not going to tank.” He pointed to McKinsey projections showing U.S. debit card transactions growing to 54 billion by 2014, a 7% growth rate from 2009’s 38 billion. That’s half the growth rate recorded between 2006 and 2009.

Among the factors supporting the debit business are consumers’ preference for the product, the strength of the underlying checking-account business, and the fact that that debit will still look attractive to banks compared to other electronic payments businesses, according to Stewart.

“The new debit economics [after Durbin] are still going to be better than competing forms of payment, “ he told a room full of bankers attending the Payments Connect expo being held in Phoenix this week by the Bank Administration Institute. He compared the income banks could earn on debit cards, even after Durbin takes effect, to that which they earn on automated clearing house and bill-payment transactions. “The ACH, nobody’s earning interchange,” he noted. “On bill pay, nobody’s making money.”

Looking at the business from a wider perspective, Stewart also noted banks are likely to earn more income over the next three years from demand deposit accounts, the checking accounts to which debit cards are linked.

The Federal Reserve is working out final rules to implement the Durbin Amendment that will cut debit income for large issuers by more than 70% and place restrictions on transaction-routing agreements. The Fed is proposing a 12-cent interchange cap on debit transactions, down from the current 44-cent average. While the amendment calls on the Fed to have its rules ready next month for a July effective date, Congress in recent weeks has been considering moves to delay implementation, with some Congressmen arguing the amendment was never fully vetted by the House or the Senate.

At the same time, Durbin is not likely to hurt credit card sales, Stewart argued on Monday at the payments conference. Some experts expect credit to suffer as merchants try to steer customers over to debit to take advantage of the newly reduced rates. But merchants will find the economics of such moves working against them, according to McKinsey research. For example, a merchant doing 10% of its sales on debit and 90% on credit would have to displace 42% of its credit card sales to justify a 1% -off incentive on debit card transactions, Stewart said. “Steering isn’t easy,” he told the audience.

The strongest factor debit cards have going for them, Stewart argued, is that consumers increasingly prefer to use them. “Debit users want to continue to use debit,” he said. “We need to figure out what to do with them.” One possibility for banks, he said, is that they could become “marketing conduits” for merchants looking to reach consumers with merchant-funded rewards. The transaction data held by banks could prove valuable to merchants, which would pay banks a fee for the information.