If You’re a Small Bank, the Trend Is Your Friend in Electronic Payments

This is the fourth installment of a six-part series exploring the growing economic tensions and structural conflicts between acquirers and issuers in the bank card business.

If you're a top-10 bank card issuer these days, the good times are looking increasingly tenuous; if you are one of the nation's 17,000 other, smaller banks or credit unions, you have a chance to get your piece of the payments business back. Since a handful of big banks control 90% of the credit card action and 60% of signature-debit card revenue, just about any new transaction you get is all upside. The key is finding the pathway to pricing payments based on their value provided to users.

The commoditization of the payment networks and the push from the acquiring side of the business to more fairly balance compensation according to effort and risk, as discussed in prior installments of this series, are actually very good news for the industry. These trends not only enable payment options that relieve smaller merchants of the burden of subsidizing the rest of the industry, but they also allow smaller financial institutions to leverage the networks they already have?such as the automated clearing house and electronic funds transfer systems?to get back into the game.

This opportunity is most clearly manifested in the online environment, where the traditional signature-based credit and debit card model is rapidly outliving its usefulness (and even its relevance) against a backdrop of multiplying options for making purchases: PayPal has an estimated 12% share of the online market in the U.S. and arbitrages various bank networks to command a 62% margin on payments?while giving merchants substantial breaks in front-end pricing and back-end risk management costs.

Bill Me Later has achieved substantial penetration of the Internet Retailer Top 500 merchants, and will soon be available to smaller merchants through a high-end online independent sales organization, offering price and cost benefits plus higher tickets and frequent upsells. Google Checkout makes payments transparent to merchants that don't want to fuss with them, and subsidizes their cost based on the ad and search spend the merchant makes.

Market share and fast-growing payments volumes are obviously in play, with projections that one in four online payments by 2012 will be made with something other than signature-based cards. And so some interesting payment options are arising for small financial institutions to help them in their fight to regain their share of the business.

NACHA, which guides the fast-growing, low-cost ACH, continues to push a payment model now known as Secure Vault Payments (SVP). By authenticating and arranging payment through the consumer's online bank, SVP offers stronger security, at a significant price break to the merchant, and available to any bank that signs up to be part of the system.

One of the larger EFT networks plans to do essentially the same thing via consumer ATM debit cards. Effectively, the consumer is “pushing” a payment to a known merchant from a known consumer, so the risk is much narrower. Just as important, the transaction clears and processes in real time (or at least same day), so the funding risk is all but eliminated. Any financial institution in the network can participate.

ATM Direct, which has new life in its reincarnation as Acculynk, can let any EFT network?and therefore any financial institution on that network?enable consumers to do online (or mobile) purchases with secure entry of their PINs via display of a host-provided “floating PIN pad.”

All offer decided advantages over signature-debit cards. If all costs, especially signature-debit chargebacks and customer-service costs, are factored in, any ACH- or EFT-based guaranteed payment priced above 62 basis points provides the issuer with higher margins than equivalent use of the signature-debit card option?despite a much higher revenue rate for signature debit. That leaves a lot of room to offer meaningful discounts to merchants while still providing more attractive margins for processors and banks alike (even for the big issuers).

This advantage has already been borne out with PIN-less debit bill payments online (or via the phone)?a market that was turbocharged with the Department of Justice's rejection last month of Visa's four-year ban against accepting non-Visa transactions on Visa cards without a PIN.

Here the consumer uses an ATM debit card without the PIN to push a payment to a known, certified biller, who gets a very clean EFT transaction. In return, the biller typically pays the banks capped rates of between 35 cents and 50 cents per transaction?depending on the market vertical.

By 2012, 2.5 billion bill payments per year will be converted from mailed-in paper checks to the online and telephone channels. Big issuers would love to see those payments converting to signature-debit or credit, which could generate fees of $1 to $2 per transaction. But these options face growing resistance from both consumers and billers.

The alternative payment option is ACH, which is cheap but sometimes messy for both billers and consumers, and earns financial institutions little if anything in revenue. So if you're a small bank, wouldn't you break a leg to promote PIN-less debit all day long? And if you're a small bank, you'd better read next week's installment, which covers changes in association strategies, including support for decoupled debit cards by MasterCard. It's eat, or be eaten, time now.–Steve Mott