Marketing: The Premature Obituary for Debit Rewards

Jane Adler

Durbin’s cap on interchange for big banks was supposed to be the death knell for debit card rewards. Instead, rewards programs are flourishing, albeit with a few twists. “Relationship rewards,” anyone?

After caps on debit card interchange rates went into effect last fall, KeyBank took a contrarian approach. Unlike a lot of big issuers that dropped their debit-rewards programs that were funded by interchange revenue, the Cleveland-based bank beefed up its offerings. Rewards could be earned not just for debit transactions, but also for online bill pay, direct deposit, and other services. The new strategy based rewards on the customer’s relationship with the bank, not just debit transactions.

KeyBank advertised its revamped rewards program and new enrollments in September and October spiked. Since then, customer use of the program has grown month over month and led to opportunities to cross-sell additional services.

“Debit card rewards are alive and well,” says David A. Bowen, director of product management at KeyBank, which is owned by KeyCorp. “We expanded our rewards as a way to differentiate ourselves from competitors.”

After the Durbin Amendment was enacted in 2010 as a part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, many predicted that debit card reward programs would be severely curtailed, or even entirely abandoned. After all, debit-reward programs traditionally have been funded by card issuers from their interchange revenue.

‘Evolving’ Rewards Market

A few big financial institutions did drop their programs, notably Wells Fargo & Co. and JPMorgan Chase & Co. And Bank of America Corp. created its own uproar when it introduced and quickly retracted a $5 monthly fee on debit transactions.

Just nine months after the Federal Reserve imposed an interchange ceiling on debit, however, debit card rewards programs are not just surviving, but thriving.

Smaller financial institutions, those with assets under $10 billion and not subject to the price controls of the Durbin Amendment, have introduced new rewards programs as a way to attract customers. And many of the big card issuers have not dropped their debit-reward programs. Instead, financial institutions are tweaking their strategies and their programs.

More rewards are linked to general checking services. At the same time, reward values have been modified to reflect the new economic reality as financial institutions contemplate the addition of new fees on checking accounts to cover costs.

Many of the debit-reward programs are now merchant-funded. Card issuers are also exploring ways to enrich rewards with daily-deal or Groupon-type offers to cardholders. “We are definitely interested in the concept,” says KeyBank’s Bowen.

Six of the top 10 debit issuers still offer rewards, according to a March report by Mercator Advisory Group Inc., Maynard, Mass. Among the 50 largest banks, 40 of the 60 programs from the previous year are still being offered in some form. Bank of America continues to operate all four of its debit card rewards programs, with some changes, the report says.

“We really didn’t see as much deactivation of rewards programs as we thought we would,” says Patricia Hewitt, director of the debit advisory service at Mercator and author of the report, “Top 50 Retail Financial Institutions’ Debit Reward and Loyalty: 2011 Annual Review.” She adds: “Everyone thought the market would dry up, but it’s really just evolving.”

Other findings from the report, now in its sixth year, include:

– A transition of transaction-based points and cash-back programs to merchant-funded models;

– Deactivation of most of the airline affinity programs;

– The integration of rewards to online banking and checking, or rewards for the banking relationship;

– The re-emergence of credit cards, a source of competition for debit cards.

To put debit rewards in perspective, Hewitt notes that the programs were never as popular as perceived. She figures that fewer than about 30% of issuers have actually had some kind of debit-rewards program. Issuers that have not had a debit-rewards strategy are probably unlikely to initiate one now, she adds.

Still, the majority of U.S. consumers prefer debit cards as a payment method instead of cash or checks. The economic downturn has also made credit cards less attractive as a payments vehicle.

As a result, debit card payment volume continues to climb. Mercator estimates that 2011 signature-debit volume totaled about $1.1 trillion. PIN-debit volume came to about $700 billion. Mercator projects that debit card payment volume will continue to compound at a very low double-digit rate for the foreseeable future.

A ‘Feel-Good Reward’

Despite the consumer embrace of debit cards, issuers have been under pressure lately because of new laws and regulations. A modification of Regulation E, issued by the Federal Reserve Board, took effect in July 2010. It required that banks not charge overdraft fees for debit transactions at the point of sale or at an ATM without an opt-in from the cardholder for overdraft protection. The loss to issuers is about $5.6 billion in fees, according to Javelin Strategy & Research Inc., Pleasanton, Calif.

Losses have continued to widen in the wake of the Durbin Amendment. Average interchange fees for big banks dropped to 24 cents per transaction from 50 cents in the last quarter of 2011, according to a May 1 report by the Federal Reserve Board. Javelin estimates the total loss to big issuers for 2012 at $6.6 billion. “The revenue loss is significant,” says Beth Robertson, director of payments research at Javelin.

Since the Durbin Amendment became law, KeyBank’s debit interchange revenue has declined by about 50%. “The amount is noticeable,” says KeyBank’s Bowen, though he declines to provide specific numbers.

Bowen adds that KeyBank never expected a revamped and expanded rewards program to somehow make up for the revenues lost because of the Durbin Amendment. But, Bowen says, the enactment of interchange price controls was viewed as a favorable time to expand and recalibrate the rewards program. “We are a relationship bank,” says Bowen. “We saw this as an opportunity to differentiate ourselves.”

KeyBank customers can now earn rewards for using payment methods other than debit cards, including checks and online bill-pay services. Bonus points are awarded to customers who take out a loan, or open a savings account. PIN- and signature-debit transactions now earn the same number of reward points. Previously, signature transactions earned two reward points for every dollar spent. PIN transactions earned one reward point for every six dollars spent. Now both PIN and signature transactions earn one reward point for every six dollars spent.

“We simplified the program,” says Bowen, admitting that the new economic realities required an adjustment of point values.

Other big banks are tweaking their rewards programs. In March, SunTrust Bank announced modifications to its rewards programs in response to changing debit card revenues. The Atlanta-based bank discontinued its Classic Level Delta SkyMiles Check Card. Changes were made to its other Delta rewards cards.

The business check card earning ratio was changed from 1 mile for every $1 in purchases to 1 mile for every $2 in purchases. Annual fees were raised on both Delta SkyMiles business and World Check cards. Fees were also moved from being charged at the card level to the checking account level—a shift being made at other banks as they attempt to strengthen consumer ties to checking accounts.

Small financial institutions see a competitive opening with debit rewards. Texas Trust Credit Union, for example, launched a rewards debit card program in August. Every transaction earns 15 cents for local participating high schools. The MasterCard debit card is branded with local high school logos and artwork.

“It’s a feel-good reward,” says Jim Minge, chief executive at Texas Trust, Mansfield, Texas, which is small enough to escape interchange caps. The program has logged more than 400,000 transactions so far. “We’ve seen an increase in transaction volume and [average ticket],” adds Minge.

‘A Revenue Source’

Like a lot of issuers, KeyBank has a third party administer its rewards program. KeyBank uses MasterCard’s debit rewards platform—a popular program with issuers. KeyBank funds the program. Interestingly, KeyBank does not currently offer rewards on its branded credit card. (The credit card portfolio is actually owned by another bank.) “We’d like to broaden our relationship rewards to include credit card spend because it’s important,” says Bowen.

Other banks are pushing credit cards again in an effort to make up for the losses associated with new regulations, though credit issuers are being somewhat cautious, industry sources say. Credit card usage is expected to climb, according to Adil Moussa, until recently a senior analyst at Aite Group LLC, Boston.

By 2016, he projects that 58% of transaction volume will be from credit cards and 42% will come from debit cards. That compares to 54% for credits cards in 2012, and 46% for debit cards. “People have a short-term memory about the trouble they had with credit cards,” says Moussa. “Credit cards are climbing again.”

While debit-reward programs are not going away, card issuers are turning more often now to merchants as the funding source.

Processor Fiserv Inc., for example, offers UChoose rewards, a merchant-funded program that includes more than 15,000 merchants. The UChoose rewards program is popular with credit unions and community banks, according to Holly Krest, senior vice president of loyalty programs, at Fiserv’s office in Morris Plains, N.J. “Banks want these rewards programs, but they have to be financially viable and relevant to consumers,” she says.

Fiserv launched a mobile application for UChoose in May. Consumers can shop the UChoose Rewards catalog or scan a product’s UPC code to see if it’s available in the catalog. Items can be purchased via a smart phone and shipped to the customer. Products from Best Buy can be picked up at a nearby store.

Affinity Solutions Inc., a New York-based merchant-rewards provider, launched its new Coupon-on-a-Card rewards program in early May. It offers a dollars-off reward at the point of sale, instead of a credit on the balance statement. “We are taking the merchant-funded model a step further,” says Jonathan Silver, president and chief executive at Affinity Solutions.

In April, Vantage Credit Union launched its first debit card rewards program with third-party provider Cardlytics Inc., Atlanta. Vantage has about 100,000 members and covers the greater St. Louis area. The credit union has about $700 million in assets and is not subject to the Durbin Amendment caps on debit card fees.

The new rewards program uses member data to offer cardholders relevant rewards based on their purchasing history. The rewards or offers are available through the online-banking account. Members receive a discount on certain items, which is then credited to their account on the next month’s statement—acting as a cash-back type reward. The merchant funds the transaction, but only when the item is purchased.

“The idea is to push debit card utilization,” says Eric Acree, executive vice president at Vantage. “It’s a revenue source for us.”

Cardlytics currently has 250 financial institutions with debit-rewards programs. The checking account is the key link to the customer. Offers can be made through the online-banking channel, text messages, or e-mail. One bank plans to make offers through Facebook in a few months. “Banks are starting to understand that their digital channels and customer data are valuable,” says Lynne Laube, president of Cardlytics. “Now they see they can monetize that.”

Tightly Coupled

But already, smaller financial institutions are feeling squeezed by lower interchange income, which could result in even more reliance on merchant-funded rewards programs. Using a provision in Durbin, merchants are routing transactions to the lowest-cost processing network, and, as a result, interchange revenues for debit issuers are declining, industry sources say.

“It’s adding pressure to the institutions exempt from the Durbin Amendment,” says Acree at Vantage Credit Union. Others agree. “Merchants are really getting educated about how to watch the bottom line,” notes Minge at Texas Trust.

Looking ahead, card issuers are expected to seek more tightly coupled banking relationships through checking accounts as they shift focus from transaction-based revenue and rewards. Financial institutions are also starting to consider what fees may be added on the checking side, with one issuer stating “the days of free checking are over.”

The debit rewards market, once a way to drive usage, is maturing. Banks are more interested in rewards tied to banking activity to create a “sticky” relationship—one that is not so easily changed. Says consultant Hewitt: “We expect a continued evolution from account-based rewards to relationship rewards.”