Fed Could Cut Signature Debit Interchange up to 60%, Goldman Clients Say

Financial-industry clients of Goldman Sachs & Co. are bracing for cuts of 40% to 60% in signature debit card interchange rates when the Federal Reserve Board releases its draft regulations for the controversial fee, possibly as soon as Thursday. Many of the investment-banking firm’s clients also expect the Fed to take an expansive view of a new law’s ban on exclusive agreements between debit card issuers and payment networks.

In all, Goldman Sachs says expectations point toward a 41% decline in overall fees, bringing the blended debit interchange rate down from the 1.25% to 1.40% range to 0.70% to 0.75%. Such a cut would take a $3.3 billion bite out of the current $8 billion in estimated interchange revenues of six leading debit-issuing banks, Bank of America Corp., Wells Fargo & Co., JPMorgan Chase & Co., U.S. Bancorp, PNC Financial Services Group Inc. and Citigroup Inc. A 41% drop, while no doubt steep, is still less than the possible 70% revenue drop BofA, the nation’s largest debit card issuer, told investors a few months ago that it could suffer if it did not take mitigating steps.

Goldman Sachs on Tuesday released results of a recent e-mail survey of its clients’ expectations about how the Fed will interpret the Dodd-Frank financial-reform law’s Durbin Amendment, which mandates that the Fed regulate the debit card interchange of financial institutions with more than $10 billion in assets by late April.

The survey generated 113 responses. Although the law limits what the Fed can consider in setting “reasonable and proportional” interchange rates, it says little about how the Fed is to treat the two forms of debit—signature transactions, which go over Visa or MasterCard rails, and PIN debit, whose transactions use EFT networks. Seventy-four percent of survey respondents believe the Fed will differentiate between the more costly signature and cheaper PIN debit in regulating interchange rates. Assuming an average interchange rate of 1.5% to 1.75% for signature debit and 0.5% to 0.75% for PIN debit, 46% of those who expect the Fed to differentiate believe regulation will cut signature rates by 40% to 60%. Another 18% expect a cut of 60% to 80%. But a sizable number of respondents, 31%, expect a smaller cut of 20% to 40%.

Respondents were less certain about PIN debit, with 31% expecting a cut of zero to 21%, 26% expecting a 20% to 40% cut, and 24% predicting a cut of 40% to 60%. “The lack of a clear consensus appears consistent with general industry observations that PIN’s current interchange levels offer the most economic rate relative to cash, credit, and checks and therefore are less likely to be reduced materially by the Fed especially relative to signature debit,” Goldman Sachs’ survey report says.

Among those who don’t believe the Fed will differentiate between signature and PIN debit, 59% expect a cut of 40% to 60% and 24% said 20% to 40%.

Meanwhile, 69% of respondents said they expect to come up with an interchange formula while 31% predict a flat rate. A Goldman Sachs analyst did not respond to a Digital Transactions News request for comment.

Dodd-Frank also bans so-called exclusive affiliations for debit cards, cards that offer only affiliated networks, for example, Visa for signature debit transactions and Interlink, which Visa Inc. owns, for point-of-sale PIN-debit. The MasterCard Inc. equivalent is MasterCard for signature and Maestro for PIN debit. Instead, a debit card must offer at least one unaffiliated network, in theory giving merchants more transaction-routing choices and potentially lowering their debit card acceptance costs. The demise of exclusive network affiliations will affect both Visa and MasterCard, but especially debit market leader Visa. Some 79% of the debit transactions from Visa’s top 10 debit issuers come through exclusive Visa/Interlink cards, according another investment bank, UBS.

As with interchange rates, the law gives the Fed wide leeway in how to implement the exclusivity ban. The Merchants Payment Coalition, a lobbying group of large general retailers and grocery chains, wants each debit card to access Visa and MasterCard as well as two PIN-debit networks. That scenario would be a radical departure from current industry practice, and many observers think the Fed will focus only on the PIN-debit side, with each card offering at least two PIN-debit options, including one unaffiliated with the signature brand on the card face.

Goldman’s respondents have mixed views: 64% expect the Fed to take a “broad” view of the law’s proscriptions about network exclusivity. Among that group, 41% expect the Fed’s rules to affect only signature debit while 40% expect them to affect only PIN debit and 19% both.

“On debit exclusivity, we believe that a broader view to include signature debit remains a low probability given the systemic changes required to have this realized,” the report says. “Our survey shows that this remains a significant source of concern for investors; therefore, a more benign interpretation should clear a key overhang for [Visa and MasterCard shares].”

The Federal Reserve Board is scheduled to discuss proposed debit card interchange rules at its Thursday meeting set to begin at 2:30 p.m. Eastern time. The event will be Webcast live, the first time the Fed has ever Webcast one of its meetings.