Though Exempt, Small Issuers See Durbin Cutting Their Debit Income by 73%

Small debit card issuers are bracing for an eventual loss of 73% of their interchange revenues despite being exempt from pending interchange regulations under the Dodd-Frank financial-reform law’s so-called Durbin Amendment. That’s one of the more notable findings from the Pulse electronic funds transfer network’s 2011 Debit Issuer Study released Tuesday.

Research firm Oliver Wyman surveyed 50 banks and credit unions of all sizes for the annual debit study commissioned by Houston-based Pulse, a subsidiary of Discover Financial Services. The study included a number of questions about the highly controversial Durbin Amendment. Pulse released its Durbin findings ahead of the rest of the survey, which it plans to release next month.

Durbin exempts debit card issuers with assets of less than $10 billion from interchange regulation. For regulated issuers, the preliminary proposal from the Federal Reserve, which Congress charged with implementing the amendment, calls for transaction caps of 7 cents to 12 cents. Many observers expect those caps to cut regulated issuers’ revenues by 70% to 80% or even more.

According to the Pulse/Oliver Wyman findings, none of the exempt issuers surveyed expects to escape unscathed once the Fed’s rules take effect. Ten percent of exempt issuers expect a decline in interchange income of up to 10%; 20% are bracing for declines of 11% to 50%, and 70% foresee a decline of more than 50%. On average, exempt issuers expect a 73% cut in interchange while all financial institutions surveyed believe their reductions will average 79%.

“The consensus of the industry is that there is skepticism that the interchange cap is going to work for those smaller issuers,” Steve Sievert, senior vice president of communications and marketing at Pulse, tells Digital Transactions News.

Exempt issuers expect the market eventually will narrow the gap between regulated and unregulated interchange. According to the Fed, only 131 issuers have more than $10 billion in assets, but they account for the majority of debit cards and transactions.

In a news release, Pulse quoted an executive of an exempt issuer who said, “We see no impact in 2011, but over time [in 2012-2013], we expect interchange income will decrease due to marketplace pressures lowering the interchange rate.” Another executive from a small issuer added, “even if a network were to offer a two-tier pricing schedule, the shift in market conditions would eventually require the interchange rate for exempt institutions to be reduced.”

Both Visa Inc. and MasterCard Inc. recently released new schedules that have no changes in debit interchange from 2010’s rates. That means the two networks will need to issue revised interchange schedules for large issuers that reflect the Federal Reserve’s regulated rates once the Fed discloses them. The Fed delayed issuing its final rules beyond the original April 21 deadline because it needed to sort through a mountain of comments, but has promised to have regulations in place by Congress’s July 21 implementation date.

Sievert says Pulse’s release of its Durbin findings now is not intended to influence the Fed or Congress. Pending bills would delay regulations for up to two years, though their chances of passage are uncertain. “That certainly wasn’t the objective of the study,” he says. Pulse wanted to release the Durbin findings this month not only because of their timeliness, but also to keep the focus in May on the massive study’s other results, he says. “You can do that without talking about the Durbin Amendment,” he says.

To make up for lost interchange income, 54% of surveyed regulated financial institutions and 27% of exempt issuers told Oliver Wyman they are evaluating additional fees or reducing benefits. Some plan to reduce rates on high-yield checking accounts, eliminate ATM fee rebates, and charge customers for their checking-account service. Banks and credit unions also expect to eliminate debit card rewards, according to Pulse, reflecting actions already announced by some banks.

Further, others plan to promote PIN-debit card usage instead of signature debit in an effort to maintain profit margins. Signature debit generates higher interchange and is marketed much more heavily by issuers, but PIN-debit cards have considerably lower loss rates. With the Fed’s preliminary rules making no distinction between PIN and signature debit, PIN debit could emerge as the more profitable product in a regulated world.

Debit card issuers also overwhelmingly prefer that the Fed choose what it called “Alternative A” in its draft rules regarding debit network affiliations. To give merchants more transaction-routing options, and theoretically lower card-acceptance costs, the Durbin Amendment bans exclusive agreements in which an issuer offers on its cards one brand for signature debit and an affiliated network for PIN debit. An example is Visa for signature debit and the Visa-owned Interlink network for point-of-sale PIN debit

The Fed’s proposed Alternative A would ban issuers and networks from restricting a card to fewer than two unaffiliated networks. Under the Fed’s Alternative B, a card must offer at least two unaffiliated networks for each method of authorization. In other words, two unaffiliated networks for signature and two for PIN debit. “This was virtually unanimous, a preference for Alternative A,” says Sievert. “It causes the least disruption.”

A spokesperson for the Durbin Amendment’s chief sponsor, U.S. Sen. Richard Durbin, D-Ill., declined to comment on the survey.