Kansas City Fed Chief Espouses ACH for Debit Card Processing

The Federal Reserve Banks should adapt the automated clearing house network to compete directly with private-sector networks for debit card processing, the head of the Federal Reserve Bank of Kansas City said this week. “The Federal Reserve could enhance competition in payment card markets by positioning ACH services as an alternative to debit card payment networks,” said Thomas R. Hoenig, president of the Kansas City Fed, in remarks delivered on Monday at a retail-banking conference held by the European Central Bank in Frankfurt, Germany. Hoenig said he isn't proposing the Fed issue cards or run its own card network. But he said the U.S. national banking regulator could “add enhancements” to the ACH that would allow the nearly ubiquitous network, which reaches virtually every bank in the U.S., “to become an alternative to running transactions over card networks.” He pointed to decoupled debit cards, in which banks issue debit cards that link to deposits held at other banks, as an example of the sort of adaptation he favors. Decoupled debit card transactions rely on the ACH network, but have lost momentum in recent months with the withdrawal from that market of Capital One Financial Corp., which had been a major backer of decoupled debit. NACHA, the rules-setting organization for the ACH, has an existing code for such transactions, the POS code. Other examples of using the ACH for debit card processing have emerged over the years. In the 1980s, for instance, a regional debit network in Arizona known as the Cactus Switch relied on the ACH for settlement. Neither Visa Inc. nor MasterCard Inc., both of which run extensive signature- and PIN-based debit card networks, responded to requests for comment from Digital Transactions News. A note on the first page of the text of Hoenig's remarks indicates his views are not necessarily those of the Fed. Hoenig's suggestion came toward the end of a speech in which he called for a more activist role by the Fed in regulating electronic payments. This role, he said, could best be discharged by the Fed acting as an active participant, or “operator,” in various payments markets, rather than as simply a non-participating regulator. This is how the Fed acts today in the ACH, where it serves as one of two operators, or switches, in the network. The other ACH operator is the Electronic Payments Network, part of The Clearing House Payments Co. LLC, a private-sector concern. The notion of expanding the ACH into the market for debit card transactions also comes as debit card traffic is rapidly mounting. Visa reported last month that debit card dollar volume in its latest quarter had exceeded that of credit cards for the first time. Debit card transaction volume began outpacing credit card transactions several years ago. The private-sector debit networks, which also include such national systems as Star, NYCE, and Pulse, require more oversight because of the concentration of market share in their hands, Hoenig said. This, he said, “has introduced new challenges to assuring the competitiveness and safety of the system.” He cited statistics indicating that the three largest PIN debit systems processed more than 81% of debit transactions in 2007, up from the 46% share held by the three largest networks in 1995. Meanwhile, the number of networks fell to 14 from 43 during that time. “Similar trends are evident in signature debit and credit card issuance,” he said. Some payments observers welcomed Hoenig's remarks. Steve Mott, principle of BetterBuyDesign, a Stamford, Conn-based consultancy, told Digital Transactions News by e-mail that the notion of “a debit card utility” like a modified ACH has merit. “ACH has grown in sophistication and utility over the years and represents far and away both the most efficient debit network option available today and the only viable laboratory the industry has for creating innovative new value to payments,” he says. He contrasts the ACH with the existing signature- and PIN-based debit systems. Signature-debit cards, he says, are too quick to impose costly fees on cardholders for insufficient funds, while PIN-debit cards are becoming increasingly expensive to merchants. “Even that highly efficient form of debit access is falling into the syndrome of padding bank revenues without commensurate increases in user value,” he said.