ApplePay: Debit issues

Update Oct 1

Apple forced all the top 5 launch partners to launch debit and credit at same time. Right thing to do!!.. but debit is messy.

My bank friends are having kittens over Apple Pay debit compliance. Issue isn’t Apple, but forcing debit cards to EMV (industry not ready) and dealing with the conflict between EMV rules and Durbin. For example, EMV rules state transaction must be routed to primary AID as identified by issuer. This is fine for credit, but Durbin requires routing flexibility… this requirement just never bubbled up through the EMV specs. Tokens exascerbate the problem, particularly if the AID is from a Visa BIN.. Specs must be updated to address need for routing flexibility (using the secondary AID) …but this breaks network rules.. and there are no payment terminals that read secondary.


Previously I stated that debit cards in ApplePay are not Durbin compliant. I am retracting that comment completely.  The debit card in ApplePay seems to be Durbin compliant, as Bank of America spent significant time with First Data’s Star network to make it so. Problem is that the rest of the debit industry is scratching its head trying to figure out how to make this stuff work… so don’t expect to see any ability for all your debit cards to work in ApplePay anytime soon.. just the top 5.

The Challenges with Debit

Debit in the US is broken down into 2 primary segments: Signature Debit (processed through Visa) and PIN debit processed through 8+ PIN Networks. See this Federal Reserve note for more background. Retail banks exert almost complete control within PIN debit, after all it is their “ATM” acceptance infrastructure that allowed for this network.

PIN Volume2

While the new EMVCo token scheme is available to Debit, coordinating implementation across 8+ PIN Networks (and large Retail Banks) is a big chunk of work. Particularly when these same banks are working to consolidate PIN networks, and create their own centralized token solution (see blog).  I’m painting a picture of many companies and many moving parts in PIN debit and tokenization. Add to this picture Apple, who worked with networks to compartmentalize and maintain secrecy with a handful of partners.

To get anything done in this environment, it is best to work with the biggest gorilla, solve their problems, show the way, and hope everyone else gets in the boat. This seems to be what happened and the Gorilla is Bank of America. This is the only Debit card I’m confident is in ApplePay. I believe BAC has been working with Apple for over 4 years on this.

There are 2 essential problems with debit in mobile wallets

  1. Debit cards must be PIN capable
  2. Debit cards have complex routing requirements (more detail below)

Durbin Challenges – Routing

The Durbin amendment requires that Debit cards give merchants flexibility in the routing debit transactions (see this excellent Paul Hastings note). From Financial Reform Insights

As noted above, all banks, regardless of asset size, must comply with the prohibition on network exclusivity and routing requirements. The Fed has implemented requirements to prohibit network exclusivity arrangements on debit card transactions and ensure merchants will have choices in debit card routing. In addition, the network exclusivity and routing requirements apply to both debit cards and prepaid cards.

The final regulation requires issuers to make at least two unaffiliated networks available to the merchant, without regard to the method of authentication (PIN or signature). A card issuer can guarantee compliance with the network exclusivity regulations by enabling the debit card to process transactions through one signature network and one unaffiliated PIN network. Cards usable only with PINs must be enabled with two unaffiliated PIN networks. ATM transactions are not subject to routing and exclusivity regulations.

Note: A smaller payment card network may be used to help satisfy the two unaffiliated network requirements; however, if the second payment card network is unwilling to expand its coverage to meet increased merchant demand for access, that would trigger noncompliance with the network exclusivity regulations.

In real world terms, the Durbin amendment allows merchants to treat all debit cards like bank PIN debit cards (they can be routed around Visa/MA switch and switched through PIN networks Star, NYCE, Pulse, Cirrus, … etc). Large merchants have also started routing debit transactions DIRECTLY TO BANKS, skipping the PIN Networks all together.  This is all very straight forward in the world of a 16 digit PAN. The merchants (or their processors) use BIN routing tables that can be customized by issuer/debit network.

Within the EMVCo Token Scheme, the only way for the underlying card to be “resolved” is from the Token Service Provider (TSP) as described in part 3.2 of the EMVCo spec.  Visa and Mastercard are the only TSPs in the current version of ApplePay. Although, both networks have committed to allow Issuers to serve in the TSP role directly none appear to be ready October 2014. These unique TSP roles are probably due to the speed at which the EMVCo spec materialized (fastest new Scheme in history of V/MA), and also to the secrecy surrounding its first use (ApplePay). Thus, in the current ApplePay EMVCo token scheme neither the Issuers or PIN Networks are in control of the tokens, and hence cannot make “at least two unaffiliated networks available” without first resolving the token with the TSP.

To solve for token resolution, each and every processor must have the ability to work with a multitude of TSPs to resolve tokens into something that could be routed based upon the MERCHANT’s options (2 unaffiliated networks). The problems here are not insurmountable and resemble the problems associated with the Internet’s DNS system, where multiple copies of DNS routing tables exist to convert to an IP address. Tokens have an added advantage of identifying the owner/TSP through the BIN. For example, a Visa debit card within the ApplePay system could be a Visa Bin, a Chase Bin, a Wells Fargo bin.. So a token identifies its “owner”, or the TSP which can translate it.

To solve for this problem, Visa and Mastercard have made a “detokenization” service available, and other TSPs/PIN networks must do the same (running Vaulting / PIN transformation).  But to do this for all cards, all processors and all merchants takes a little time. There are technical and business issues here.

What is most surprising to me? I spoke to the head of debit cards at a top 5 banks, and he didn’t even know there was a problem..

PIN Capable

While it is great that they included debit in the launch, the debit issue had plagued other schemes as well. ISIS initially launched with a Chase Debit account to hold balance. Chase’s regulator told them that this card was not compliant (no PIN capability) and thus they had to pull weeks before the ISIS launch. ISIS had to run to Amex Serve for the solution, as Amex was not under durbin constraints. This PIN issue will also hit ApplePay, but the more immediate problem is routing.

Google solves the PIN problem by wrapping in a non Durbin debit. Specifically, banks with under $10B in assets, and non-banks (like Amex) don’t have to comply with Durbin. Google thus has one token (non Durbin debit), where they are issuer with Bancorp Bank (TBBK).

I am laughing a little bit on the PIN side, can you imagine, unlocking your phone, touching the ID, tapping to merchant, then also keying in a PIN. Merchants are in a place to “steer” toward PIN for every debit card. But downside is that if consumers get too frustrated with experience they will just use their credit card.

Merchants know…

A few months ago, “a merchant group” sent Apple a “formal notification” telling them that their scheme was not Durbin compliant. I don’t know if Apple’s team just sat on the notification, or hoped it would just go away once all the good launch activities came to pass.  I’ve been convinced over the last 2 days that there is a durbin compliant card in the wallet, but Apple Pay is certainly not ready for every debit card. Why didn’t Apple respond to the merchants and tell them they were investing to make sure this works? It is not a great way to start off a relationship… particularly when you have your own plans for engaging the consumer.

This is the graph that merchants see in their minds when they think of Apple pay

non cash payment

Notice the flat line on credit card spend.. and the 20%+ CAGR on debit. Merchants worry that the strong banker presence at ApplePay launch is a key message.

Industry Confusion

My friends in the Debit industry are scratching their heads this week: Retail Bankers (debit card owners), Processors, PIN Networks and Merchants. What do they do to get their debit cards in ApplePay? If only one of them is ready (meaning has ability to resolve and or issue PIN debit tokens) what does it mean for the other 7?. Is this the first path toward an industry PIN consolidation? Who “owns” the token resolution service, standards and approach? What are the service levels on directory synchronization and response times? No one told them about an industry body to standardize… Man this debit stuff is complicated.

The underlying PIN Network industry problem is there is really no single authority to coordinate EMVCo token implementation across 5000+ banks and 8+ PIN Debit networks. Perhaps there is really no single way to get debit cards into a wallet, and this mess just further helps the 800lb gorillas that can invest in semi-proprietary schemes to get it done.



Payments.. global growth.. with controlled chaos

6 April 2014

Sorry for the poor flow here. jumping on a plane and wanted to get some of this out. feedback appreciated.


A brief view on what is happening in global payments growth, debit, banking and data. Why moves here are so important to banking, commerce and payments.


Nothing will dent the 20%+ CAGR of Visa/MA, as 92% of electronic transactions are completed by less than 10% of the world’s population. Perhaps the best analysis done on global payments is from Cap Gemini (2013 World Payments Report). Markets like Asia and CEMEA are growing electronic payment volumes by over 22% CAGR. The network effects are enormous, it is like mobile in the late 90s, or the internet since the mid 90s. No investor can stay out of payments.


Payments is a rather complex environment. I’m not speaking from a technology standpoint, but from a value, control, political and regulatory one. Just as electronic payments are exploding internationally, there are several forces that are acting against established payment networks in OECD markets. For Example

Thus, It is important to view the changes occurring in payments with changes in other networks: social, telecommunication, retail, mobile, supply chain, demand chain, advertising, banking, commerce, education…etc.  The lines that separate retailers, advertisers, platforms, MNOs, Banks, … are beginning to blur much more substantially. For example

Historically Banks supported commerce by providing access to capital, support of markets, specialized instruments, all of which created value through their unique ability to manage risk (using their information advantage).  Consumers chose banks based upon their physical presence to support  the interaction with (and transformation of) different forms of value: cash, check, electronic, …etc, as well as gain access to credit, and provide return on assets.  Bank strategists created retail financial “supermarkets” where transactional accounts acted a loss leader to cross sell 100s of other consumer financial products. The majority of consumers never participated in this cross selling effort, and therefore the mass remains unprofitable to these “supermarket” banks.

As cash, and check are displaced by electronic payments, the value of the branch and “supermarket banking” has shifted to the value of electronic payments for a large majority of the population. The information advantage that best positioned banks to manage risk has decayed. Further, the billions of dollars spent in transactional risk management has been eliminated by mobile authentication (see Perfect authentication a nightmare for Banks). Regulators are working globally to open up payments to non-banks (ex EU ELMIs), but conversely holding banks responsible for everything. Governments and Banks have grown addicted to data surrounding electronic payments, leaving many consumers to search for anonymity (ie Bitcoin).

The entities that are currently best equipped to deliver consumer value and monetize data are companies that the consumer most frequently chooses to interact with (Apple, Amazon, Google, WalMart, …). Banks are working from a position of control, and must pivot to a position of value, trust and choice.

A Story….

Most of you know that today’s Google wallet has a central transactional account of a non-Durbin Mastercard (see blog). Google pays each issuer with a card in its wallet the FULL rate on its cards (example 210 bps to FDC/Visa/Chase) and the merchant incurs a debit fee of 105bps. Google eats the cost.. In this model the bank wins, and the merchant wins. The consumer wins because they can put their preferred payment instrument in the wallet (ie Debit). In fact Google is the ONLY wallet that has debit cards in it.
You would think everyone would like this right? NOPE. Banks want Google to stop wrapping their cards. What are Banks upset by?
#1 Banks don’t like Google seeing the data,
#2 Banks don’t want debit use on mobile.. they want mobile to be a premium credit service
#3 Banks want part of GOOGLE’s revenue in addition to their full interchange.
This story should scare the pants off investors in the payment space, Google has invested a billion dollars, takes a loss on every transaction and has a value proposition for everyone.  (see blog)

My recommendation to Google? Tell the banks that they can shut you off whenever they want to. It is in their control to decline your transactions. I can just imagine the customer message from Google  to a consumer “your bank has decided they don’t like you using your credit and debit card with us, here are a list of banks that you can use, ….” .My recommendation to the Banks? Don’t trust Google with your data, find a way to work with them to accomplish your objectives. I have several ideas for you if you want to chat.

Five important takeaways from this section:

  1. There are no technology problems in Payments
  2. Mobile handsets and authentication are a threat to banks
  3. Banks are running away from the mass market, and Retailers/MNOs are running to fill the gap
  4. Google has done all the right things, invested a billion, takes a loss on every transaction and still can’t get traction with retailers or banks.
  5. Customer CHOICE is a threat to established players

Durbin – What Happened?

As reported Friday (see Bloomberg), the 3 judge panel at the US Court of appeals upheld the Federal Reserve rules, overturning Judge Leon’s ruling that “The court concludes that the [Federal Reserve] Board has clearly disregarded Congress’ statutory intent by inappropriately inflating all debit-card transaction fees by billions of dollars.” and the Federal Reserve failed to ensure that merchants enjoy access to “multiple unaffiliated networks” to process each debit-card transaction, as also required by the Durbin Amendment. Senator Durbin reacted to this Friday stating that the appeals ruling was “a giveaway to the nation’s most powerful banks and a blow to consumers and small businesses across America.”

Retailers and Senator Durbin argue that the clear language of the law directed the Fed to set the price of Debit at “reasonable and proportional to the cost incurred”. The Fed’s internal team came up with $0.12, but the Fed then came up with $0.21+5bps. Judge Leon had struck that fee down in July 2013 (see analysis here). For more background on Durbin and Fed see this this Federal Reserve Article.E:\Pictures\Blog\2013 number of payments in US.PNG

Debit – Industry Perspective

Debit is the most frequently used payment product in the US, with the lowest fraud rates (see Charts, and Federal Reserve 2013 Payment Study). Debit is a product that evolved from your Bank’s ATM network. This is why you have all of those logos like NYCE, PULSE, STAR, Interlink, … on the back of your card, and why you also use the card to get cash out of the ATM. I covered this topic 2 years ago in Signature Debit is Dead. Visa’s big innovation was turning their 1987 interlink win from a PIN debit acceptance network to a signature network. By placing the Visa log on the debit card, and forcing the “honor all cards” rule on merchants, they successfully drove network expansion. As the NYTimes outlines

Seizing on this odd twist, Visa enticed banks to embrace signature debit — the higher-priced method of handling debit cards — and turned over the fees to banks as an incentive to issue more Visa cards. At least initially, MasterCard and other rivals promoted PIN debit instead.

Why all the regulation? A picture is worth a thousand words

E:\Pictures\Blog\interchange rates US Fed 2.PNG

Clearly the pricing here does not seem to indicate that effective market forces are at work, as debit network expansion was followed by tremendous fee increases.

Canada, Australia, UK, most of Europe have debit pricing of around $0.12.  A fantastic analysis of all these countries was done by Europe-Economics in The Economic Impact of Fee Regulation in the UK – June 2013. The universal regulatory goal is to establish (or retain) debit’s role as the central access point for transaction accounts.  As in the Australian example, the hope was that the removal of debit fees would result in merchant savings, which would in turn result in consumer savings. Unfortunately, banks successfully recovered most of the lost interchange through new bank fees, and merchants did not pass along the cost savings.

In Australia, 85 per cent of debit card transactions are processed using an EFTPOS terminal. Interchange Fees (IFs) for such transactions are imposed in inverse direction to that of credit cards as they are paid by the issuing bank to the acquiring bank. [Post regulation] Issuing banks suffered from a revenues reduction from IFs worth AU$647m for 2006. However, as in the Spanish case, banks responded to the reduction in their revenue from IFs by increasing the level of other fees. Annual fees increased by AU$40 on average, which for 2006 represent an estimated AU$480m in issuer revenues. As a result, issuing banks recovered 74 per cent of the lost revenue from IFs.

Beyond debit, Europe is considering caps on credit card as well (see Digital Transactions – Europe’s Fee Conundrum). Visa Europe Fee structure provided below for background.

E:\Pictures\Blog\Visa Europe Fees.PNG

For more detail see my blog Debit Wars. My summary view is that debit payments are going toward a common bank owned service operating at cost (Average $0.12 globally). Visa is impacted slightly here as 19% of revenue is from debit. Thus banks are working aggressively to move payments to high margin credit.

Retail Banking Impact

This debit dynamic plays heavily into a larger retail banking strategy (see Future of Retail Banking, and theFinancialBrand). The business of managing your transactional account was never a great business for a bank. Gallup estimates that retail banking is unprofitable for 80% of consumers, McKinsey’s analysis shows it is over 40%.    Durbin’s impact on debit fees cost US Retail banks over $7B (see Forbes).

E:\Pictures\Blog\retail banking branch transactions.PNG

Branches have historically been the #1 factor in consumer acquisition. During my time at Wachovia, over 80% of our customers selected us because we were the closest branch to home or office. This branch convenience is still the primary factor, although actual use of the branch has gone down dramatically.

This, together with the maturing of digital channels, has led to a culling of branches with banks like Chase looking to take upwards of $1B from branch cost.E:\Pictures\Blog\branchesA.jpg

The US is progressing along the lines of Australia, as the non-exempt banks add new fees to make up for the debit loss (see American Banker). However, unlike Australia, the US has 2 alternatives: Exempt Banks/Credit Unions (CUs), and Pre-paid Cards. Deposit growth in the exempt banks is growing 5-6% YoY, but the real winner seems to be pre-paid with growth over 36% (See 2013 Fed Payment Study and Bank Innovation ).

My simplistic analysis of pre-paid is that the growth is driven more by a need for access to electronic payments (by the unbanked), than a need for “banking”.  Example.. need to buy something on Amazon. This seems to fit well with experience of other unbanked success stories globally. A way to view this is that value of traditional “banking” is shifting to the value of electronic payments for a large majority of the population.

What we have seen is that the Value of a big bank brand is diminishing very quickly. The brand, infrastructure and data advantages that banks held are rapidly diminishing in value. The big buildings and beautiful vaults have no advantage over an Amex Bluebird card in a box (deposit insurance levels the field for everyone). Retailers, MNOs, and Platforms have better brands, better pricing and more physical distribution and/or direct consumer “touch” than banks could ever hope for.

Nothing in this area changes quickly. But here is what I see as the most likely strategies by key players.

Non Exempt Banks (Citi, JPM, BAC, WFC, …)

Strategy #1 – Try to leverage data advantage, and grow data services (JPM)

Strategy #2 – Go up market (Citi)

Strategy #3 – Be the best retail bank (BAC/ WFC). Protect consumer information

Strategy #4 – Get into the Mobile/data/advertising space

Strategy #5 – Develop new bank lite product (ex Chase Liquid). Seems to be going poorly as they just killed the product

The modern form of retail banking envisioned a “financial supermarket” (see Forbes Sandy Weill) where the transactional account was a loss leader for cross selling 50 odd other products, the new “banking like” product is centered around electronic payments with an access network (think Greendot, WU, ATMs, …) to get money into and out of the system. Ubiquitous merchant acceptance, and employer direct deposit further drives out the need to provide “cash out” facilities (branch like services) within the network. This simple payments product fits nicely into retail environments with regular foot traffic.

The Non-Exempt Bank dilemma now becomes apparent. A classic “innovators dilemma” where the loss leading core deposit account has been undercut by pre-paid for a majority of consumers, as the services surrounding electronic payments has made branch distribution a significant millstone in cost to serve. As if that weren’t enough, 90% of the money supermarket products must be sold face to face (need a branch).  While the retail bank could adapt to compete, the rest of the organization is forcing it to keep the branches and move upstream to the affluent high margin clients.

Tech Companies

The biggest news for payments investors is that Apple, Google, Amazon DO NOT want to have their own payments network. They are all consumer CHAMPIONS.. They all want the consumer to have their CHOICE of payment instruments “Let the consumer decide how they want to pay” is their common mantra. I heard again this week that Google wanted to buy paypal and I spit out my coffee laughing.. “where did you hear that bullshit?” Not only is this a regulatory headache, it is not the centerpiece of how any of them make their margin. Customer choice is highly disruptive barrier to entry in a commerce/mobile platform. This is why Apple’s BOD decided not to buy Square in Jan/Feb.

Apple: Consumer Champion and Gatekeeper

See Apple in Commerce

Apple is setting itself up as the consumer champion. They are not great at partnerships, advertising, data… but they are great in just about everything else. Apple’s will keep your data safe in the phone, in the store and in the cloud. Consumers anonymity will be protected… even wi-fi tracking will be nearly impossible. UUIDs are a thing of the past for advertisers. If you want to know who an apple iPhone customer is.. you will need to work with Apple.

Apple is well positioned to benefit from the future tsunami of issues concerning data privacy. They are most focused on adding value to the consumer.. rather than retailer, advertiser or bank. They have the best consumer demographic on the planet and you will work with them in their model if you want to play.

Funny story here. The big banks were approached by Apple a few months ago to “pay” for getting their cards into the new iPhone wallet. The banks immediately called up V/MA and said “you guys are going to let Apple PATENT the process by which my card goes from their phone to the POS!!?”. Hence the rushed joint announcement on tokens (see PR here). Yep.. Apple made that happen.  The funny part comes in later.. Apple now has some small changes to accomodate new V/MA standard but the banks ask apple.. “we would really like that biometric.. can you send it to us”… my guess at Apple’s response “price is the same as card registration we told you before announcement”.


Consumer Champion.. but with all of your data too.  Much less robust security plan, but the best in class company for orchestration. See blog for detail.  Google is attempting to work with Retailers, banks and advertisers. They are proving their value to consumers everyday with services that help them gain more consumer insight which in turn feeds better services. Google has no desire to be a bank, or a retailer… their value is in bringing everyone together. Just like apple, their fist priority is to the consumer.. everything else flows from that.


… will need to make this a part 2. Obviously retailers differ on consumer choice just a little..

Debit Round 2 – Rates $0.21 to ?$0.05?

There is a school of thought that “pricing debit” for consumers will help banks increase credit transaction volume (ie credit cards are “free” and have points, debit cards will have monthly fee). Merchants must therefore act to build incentives around debit card usage, or a decoubled debit like product (see blog). Target Redcard is clear leader in the US.

1 Aug

Yesterday’s WSJ Merchants Notch Win in Feud Over Debit-Card Fees

Dodd Frank requires the Fed to set Debit interchange at a rate that reflects actual cost of processing. What the Fed did in 2011 was actually set rates at almost exactly the rate of PIN Debit. (see my 2011 blog).

US Retailers have been pushing for $0.05.. The Fed’s own internal team was recommending 0.12, but the final 2011 rate was $0.21 + 5bps. My view is that Governments should never set rates in an effective, competitive market. Their track record is just awful. But unfortunately payments are not competitive, but a form of 3rd party payor… a market type which is even worse than a government price controlled one.  Big Retailers know enough to negotiate great rates (as in health care) and swallow the “accept all cards” requirement. Small merchants get completely taken (just as in Health Care).

Visa/MA impact.. none. Visa’s revenue is not so much in the network fee on PIN or signature debit, it is in the DPS hosting of debit processing. Bank impact.. absolutely. If Debit interchange lands at less than $0.12, the forces behind debit consolidation (see blog) will accelerate, not because of M&A, but because the margins in this business cannot possibly sustain 6+ participants.

The Banks had planned a uniform march to add fees to debit card, but unfortunately Brian Moynihan at BAC could not wait for his peers and jumped the gun.. only having to pull back from the tremendous public reaction.  Adding fees to debit is a certainty if rates drop. The bottom 4 deciles of mass consumer are already unprofitable. Banks are a private enterprise and should not be obligated to do anything “at cost”. We thus shift costs from merchants, onto banks, who will then shift back to consumer. But quite frankly this is where they should be.. where the consumer can see them.

There is a school of thought that “pricing debit” for consumers will help banks increase credit transaction volume (ie credit cards are “free” and have points, debit cards will have monthly fee).    Merchants must therefore act to build incentives around debit card usage, or a decoubled debit like product (see blog). Target Redcard is clear leader in the US.

My idea for getting around regulation (which all parties agree is a bad thing), is 2 fold: Require transparency (by all participants), and enable competition (through access to core deposit accounts).  Imagine if Walmart, or United Airlines were required to publish their lowest interchange rate with each issuer, for every product (credit/debit). I believe retailers would support it wholeheartedly, but the issuers would go nuts.  Per the second point (account access), the UK led the way here in Faster Payments back in 2008 (see blog).  Consumer banks would need to be absolved of fraud loss responsibility if initiated as a debit by 3rd party (Onus on ODFI), but it would also allow a Sofort type model (Push payments) to prosper.

From a pure debit perspective, Australia and Canada have made Debit a common nationalized infrastructure service, part of a Bank’s requirement to have a license. Fedwire is our equivalent in the US, although only used for wires. You don’t see much payment innovation in Australia or Canada, as the common infrastructure works so well.. that there are no pain points.  The EU is also getting there with SEPA, although the inability for EU mandates to make their way into local law and requirements is proving to be a significant drag…

For innovators the message is simple.. payments are becoming dumb pipes. Go visit Canada and Australia to see why new payments schemes do not take off… Most know my view that payment is only the last “simplest” phase of a very long and complex COMMERCE PROCESS.

PayPal at POS?

The most frequent question I get from eBay’s institutional investors and start ups is about PayPal’s opportunity to win at the POS. I met with 3 top Retailers who have been pitched PayPal’s new service. Quite frankly they were laughing.. it goes something like this

18 Nov 2011

The most frequent question I get from eBay’s institutional investors and start ups is about PayPal’s opportunity to win at the POS. I met with 3 top Retailers who  have been pitched PayPal’s new service. Quite frankly they were laughing.. it goes something like this

“we [Retailers] just won Durbin and are in the midst of planning how we incent customers to use their debit card … and we get presentation from PayPal with a rate of 150-200 bps..  am I going to loose any customers because I don’t have paypal payment? Will Paypal bring me new customers that would not have shopped here in the first place? Is there going to be a 100% conversion of credit card customers to paypal? Why on earth would I want to do this?”

PayPal of course is also pitching a gaggle of new mobile tools that let people scan in aisle and shop online to pick up in store.. but does a retailer really want to outsource this?  PayPal’s core value was built around commerce, specifically the new form of commerce that eBay marketplaces brought. Buyers and sellers flocked to a tool that met their needs. No one came to eBay because of PayPal.  Payments are just the last phase of a successful commerce interaction. PayPal still has tremendous global opportunity, but their opportunity is an evolutionary one driven from their COMMERCE core. Their business model (and cost of funds) does not adapt well to the physical world.

PayPal has no tools in its shed to deliver incremental value within a PHYSICAL commerce orchestration role. They simply do not touch consumers or influence them prior to purchase. Facebook, Apple, Google, MSFT all have a much better chance of orchestrating commerce..  This is why Google’s Wallet will win against ISIS… the business opportunity is commerce orchestration…NOT about mobile payments. Never before has a customer had the ability to interact real time in store with products and offers.  Who will win? Which company above has a sales force of over 2000 globally selling to retailers today? Driving business growth? There will be no contest here.

How can PayPal use its tremendous consumer network to deliver value off of eBay?  The answer revolves around what they “could” orchestrate.. perhaps in a junior capacity.  What problems can they solve? If PayPal’s biggest asset is Consumers.. and objective is physical commerce… why not create a “reverse auction” for goods? Let consumers describe what they are in the market for and have sellers bid for the privilege to sell (and service) it. Give consumers option to buy it now in store down the street. This would relegate physical retailers to competing on price alone.. and certainly would not make them many new merchant friends…but they could start off doing this for excess inventory or mark downs.  This could be a very stupid idea.. but PayPal’s efforts to go head to head with Visa and MA in an area where they add no value at a high cost is not much better.

One corollary here is that Payments will become dumb pipes. Banks had a traditional role as the intermediary in commerce. They have fouled the well.. and continue to cry against the harm done to them by Durbin instead of engaging in an honest assessment of the future of their business.  Banks believe they have a lock on payments.. and similarly to ISIS engage in a strategy of control instead of value delivery. This dynamic will push “Commerce orchestrators” to find the path of least resistance (least cost routing) for payment. Not all payments are the same, for example Credit card payments are much different.. because they extend financing to benefit merchant consumer and bank. However there is no reason to force everything through this CREDIT card channel, which is precisely what the banks are trying to do with NFC (for example there is no debit NFC product.. it is not a technical issue but a business one).

Even if payments are dumb pipes they must have a reservoir to pull from, either in a DDA, stored value account or credit line. During my meeting with the Kansas City Fed last week, I discussed the McKinsey report describing how the bottom 4 deciles of retail banking customers are unprofitable. In other words the big 5 banks are trying to find a way to sponsor “switch your bank day” for 40% of their customers.  Many will leave the banking system all together, and this reservoir of funds will translate to cash, pre-paid or some other non-bank product. Banks loss of control over DDA is a slippery slope. If every American has a PayPal account, an iTunes account, an Amazon account, a Google Wallet and a pre-paid card they could find their control strategies are no longer effective.

I apologize in advance for the brevity of this note, and I certainly appreciate comments.. but this is how I see it.

Debit Fees – Newton’s third law in banking

In the next phase of bank plans, expect the Visa logo to disappear from the standard card issued for a base checking account. The card will operate as ATM card, just as it did 20 years ago. As a side note, the banks (and PIN Debit networks such as Star, Pulse, NYCE) will be working with merchants and processors to expand adoption of PIN Debit separate from the card networks.

2016 – This post is 4+ years old now.. I wouldn’t take it too seriously.. but good historical context

1 October 2011

First… 2 paragraphs of venting and perspective.

I was quite surprised to see BAC’s $5/mo debit card fee on the national news today. Personally, I think it is a great thing.. customers should pay for services they want to use.. sticking the merchant with the cost of debit leads to some very poor incentives. One of the biggest “innovation stifling” problems we have in the US is that consumers don’t care about prices, for things they should (payments,  health care, fraud, education, … ). The cause? the direct costs are hidden. Once consumers bear direct costs for services, market forces can take hold.

This is not to say I’m a supporter for HOW the Durbin change came about.. Dodd-Frank, Wall Street Reform and Consumer Protection Act represent the most sweeping changes to financial regulations in the United States since the Great Depression. From my perspective the timing could not have been worse. Did Congress think  the banks would just sit on the sidelines and patiently suffer? After being forced by regulators to act in good faith and “acquire” ailing community members like Country Wide? To suffer again as State AGs and the CPFB go after them for a few billion more (robo-signing).  Retail banking is becoming a very unattractive business, particularly in the lower mass market segments.  For the recovery to take hold, we need banks to be healthy…  these are not a bunch of “fat cat” millionaires.. but a core component of commerce that is instrumental in managing the lifeblood of our economy.

Debit Reaction.. equal and opposite

Well the banks have reacted to the finalization of Durbin fees. As I related in my previous blog on Debt, the fee plans have been in the works for some time, and for good reason: the lower mass segments are no longer profitable. US banks are well capitalized…. with excess liquidity, and a cost of funds near zero. There is very little incentive for them to seek to increase their deposit base (improve liquidity ratio). The core issue in retail banking profitability is asset quality (few qualified people to lend to… who want a loan). This is even more true now that Dodd-Frank has virtually gutted retail banking fees.  Two excellent articles below detail the role of transaction revenue and service fees in retail banking.

Of course not all consumers will be paying this $5/mo cost. For example, the folks reading this blog will likely have account relationships that warrant a fee exception. Mass market customers will likely be up in arms and seek to move their accounts.. believe it or not.. this is what the large banks want to happen since many of the lower tier customer segments are no longer profitable.

See this American Banker Article for more detail on alternatives to mass market customers

In the next phase of bank plans, expect the Visa logo to disappear from the standard card issued for a base checking account. The card will operate as ATM card, just as it did 20 years ago. As a side note, the banks (and PIN Debit networks such as Star, Pulse, NYCE) will be working with merchants and processors to expand adoption of PIN Debit separate from the card networks.

Market Forces in Payment

Now that consumers have to bear the costs of using a Debit Card. They have new choices:

1) Use credit card. This would be best for the banks, and perhaps best for the consumer as they collect merchant funded card reward points. The looser here is obviously the merchant. An important point  to make here is that this is exactly the strategy behind new NFC based mobile payment types.. there are NO NFC enabled debit cards.. banks and the networks want you using your phone for payment to drive credit card usage.  This is also the strategy behind Visa’s new EMV mandate, to drive retailer reterminalization. This will be a subject of a future blog.

2) Leave the bank and use pre-paid cards. This will certainly be the path for many lower mass customers

3) Pay the fee

4) Improve your relationship with the bank to meet a threshold and avoid the $60/yr fee.

5) Shift your transactional relationship to new “non bank” structures like PayPal or Google Wallet (both of which are licensed MSBs in all 47 states).

Downside for banks

CEOs make decisions based on data they have. The first 4 options have all been through. I would profer that creating a market for new competitors has not. I outlined in my previous blog “Banks will WIN in payments.. but WHICH ones”  that banks are firmly in the position of control today.  However there is a strong correlation between control and value delivered. In my upcoming blog I’ll describe how to value a payment network. My view is that payments are on a course of a utility service (i.e. dumb pipes with least cost routing), and that payment services are only the last step of a much more important commerce interaction. Any network business is highly dependent on balancing a value proposition between participants. Today retailers and consumers are not pleased. I only wish I could tell of you the wonderful things I’m seeing in Silicon Valley… IT IS NOT about technology.. but about creating business value.

Within 5 years, I see the strong possibility that a new network which will be able to PAY merchants for accepting a payment method..  (see my 2009 Blog on Googlization of Payments).

BTW… sorry for the lack of content this last month.. I have 15 page blog I’m about to publish.. I will never again try to write so much in one article.

Signature Debit is Dead

Yesterday’s announcement doesn’t impact PIN debit rates (for average transaction), but remember there are other elements of Durbin (routing and steering), which will eventually act to kill Signature debit.

29 June

Death of Signature Debit

It’s hard for the banks to complain about yesterday’s Durbin caps. At $0.21 + 5bps, the caps provide no loss in revenue from a today’s average PIN Debit transaction (see yesterday’s blog). The loss is in Signature Debit. As I related in my post a few months ago, PIN Debit evolved from bank owned ATM networks while Signature Debit evolved from the card networks (and associated credit products).

ATM Networks grew as groups of banks banded together to monetize ATM infrastructure, and further expand network into the retail POS. This expansion led to further change from bank ownership to independence. The driver of any independent network is to add volume, nodes and services. ATM Networks evolved into PIN Debit Networks, with Visa’s 1987 contract to operate Interlink as the key milestone. Today, Pulse is owned by Discover, Star by First Data, Interlink by Visa (these 3 make up over 83% of PIN Debit Volume).

Visa was and has always been the leader in signature debit penetration, a look back at this 2003 article provides much insight into the history here. Most US consumers today don’t understand why their debit card has both a PIN and signature feature… many books could be written on this subject alone… but oddly enough consumers prefer PIN (see Pulse Federal Reserve Presentation 10/10).

Signature-based transactions currently have a lead on PIN Debit. In 2009, Fed reports signature as having 23.4 billion purchase transactions, and $837 billion of transaction value while PIN-based debit transactions totaled 14.5billion transactions, and $555 billion of transaction value.

However, PIN Debit enjoys a slightly higher growth rate (15.6% vs 14.3%), consumer preference (48% vs 34%), lower fraud rate (2009 fraud numbers: Signature $1.12B, $181M PIN debit card),  and obvious merchant preferences (interchange and fraud; 96% of PIN fraud losses assumed by issuers, vs 56% in Signature).

Retailer View

While yesterday’s announcement doesn’t impact average PIN debit rates (for average transaction), there are other elements of Durbin (routing and steering), which will eventually act to kill Signature Debit. Let’s first take a retailer view… Historically, retailers have been constrained in their attempts to deny signature debit transactions. Network agreements forced them to take “all cards”. The primary merchant “influence” mechanism was to default payment terminals to “enter PIN” and make it difficult to for a customer to use a signature debit card. While Durbin does not impact the “accept all cards” rule, it does allow for merchants to route debit transactions outside of the card network.

When I spoke with a few of Visa’s institutional investors last week, much was made about 30% PIN debit penetration. Its very important to note that this penetration is on merchant terminals, NOT as a percentage of total payments. Small merchants remain rather ignorant of their payment options. This merchant financial literacy issue, combined with ISO sales incentives, has led to an uneven PIN Debit adoption.. but this will change not only for small merchants, but also for ONLINE transactions. PIN debit has had no traction in eCommerce because retail banks (issuers) did not want the lower interchange and refused to accept PIN transactions from online merchants. This has also changed. (I have detail here.. but can’t really discuss in the blog)

Bank View

At least 2 of the major banks in the US are working with processors to establish direct “BIN routing” and circumvent all network fees. This makes complete sense for the larger banks like bank of America, with 10%+ of US Debit volume, as it would enable them to eliminate network fees. Merchants would also benefit with a lower cost (the purpose of this routing provision). The key activity necessary to make this happen is to enable major processors to sort and redirect transactions. Processors already perform BIN lookup, but instead of going to Visa or MA with a BIN.. they will be going directly to a large bank. Obviously BAC/BAMS, JPM/Chase Paymenttech, FifthThird, …etc would be the top teams implementing this model. With Durbin at $0.21 + 5bps they actually can improve their margin on PIN debit.


The obvious corollary here is that once a bank is successfully routing transactions directly from the processor(s), what Value does Visa bring at all?  1) Merchants that are not using a processor that has not yet implemented the bank direct routing 2) International Debit Transactions, 3) ?Signature debit bank agreements?

As Bank “inertia” is directed toward maximizing bank margin, and merchants in decreasing debit processing costs, a new debit network is formed… and today’s Visa  debit network begins a slow death. First to go will be PIN debit, but closely following will be the removal of the Visa logo off of all debit cards. The 2 countries where this has happened are Canada (interact) and Australia (EFTPOS). The next phase of death will be begin when banks recognize the synergies of maintaining a common directory with centralized authorization and fraud controls. The model here for the US is SEPA Debit.

Tom’s Predictions (Market)

1) 2 major banks will launch their own PIN debit network… starting with processors they control

2) Signature debit, as we know it, will die

3) Visa and MA logo’s on debit cards will have a slow death over next 5-10 years. With little impact to affluent customers in short term.

4) Card issuing banks will look for new ways to grow credit use. (Mobile payments, juicing rewards, educating consumers on unique Reg Z protections, …)

5)  Merchant will be testing models to tie incentives to debit use and even create new products (Target Redcard is model)

6) Retail banks will be pushing out low end mass market customers. Pre-paid business will pick up the slack. Most of the major banks have solid plans on pre-paid card deployment.. but have delayed launch because they don’t want to be seen circumventing Durbin (see below)

7) Processors will pick up new fee revenue for “least cost routing”, but regulators will be keeping an eye on them to ensure that the bank owned processors are not acting in concert to circumvent cap definitions (see below)

8) Online PIN debit will begin to take off

9) PIN Debit merchant adoption will start to accelerate in 1-2 years

10) Visa’s US transaction processing volume will stay steady. Debit volume will go down, but processing margin will improve and pre-paid will begin to take off.

11) Banks will begin to couple payments with incentives in an attempt to avert retailer led models.. Look for BAC to be the leader here.

What does this mean for Visa earnings?

My summary view is that Visa has plenty of runway on international credit growth.. but their trajectory now has much greater risk ask it will be tied almost exclusively to credit. Visa’s recent success in processing services (ie DPS) wont suffer short term as the top 5 banks have minimal services with them.. but we will see erosion of debit revenue beginning as transaction volume further accelerates to PIN debit routed outside of Visa’s network and PIN debit adoption in small merchants accelerates.

Per final regs –  75 75 FR 81722, 81731 (Dec. 28, 2010).


ii. An issuer replaces its debit cards with prepaid cards that are exempt from the interchange limits of §§ 235.3 and .4. The exempt prepaid cards are linked to its customers‘ transaction accounts and funds are swept from the transaction accounts to the prepaid accounts as needed to cover transactions made. Again, this arrangement is not per se circumvention or evasion, but may warrant additional supervisory scrutiny to determine whether the facts and circumstances constitute circumvention or evasion.

Processor Fees

Merchant commenters voiced concerns that issuers may attempt to circumvent the interchange fee standards (applicable to those fees ―established, charged, or received‖ by a network) by collectively setting fees and imposing those collectively set fees on acquirers, and ultimately merchants, through the networks‘ honor-all-cards rules. For example, the largest issuers may collectively determine to charge interchange transaction fees above the cap and effect this decision by dictating to each network the agreed upon amount. The network, then,would permit each issuer to charge that amount, and because merchants would be required to accept all the network‘s cards, merchants would pay the amount determined by the issuers.

Section 920(c)(8) of the EFTA defines the term ―interchange transaction fee‖ to mean ―any fee established, charged, or received by a payment card network . . . for the purpose of compensating an issuer for its involvement in an electronic debit transaction.‖ Accordingly, interchange transaction fees are not limited to those fees set by payment card networks. The term also includes any fee set by an issuer, but charged to acquirers (and effectively merchants) by virtue of the network determining each participant‘s settlement position. In determining each participant‘s settlement position, the network ―charges‖ the fee, although the fee ultimately is received by the issuer. An issuer, however, would be permitted to enter into arrangements with individual merchants or groups of merchants to charge fees, provided that any such fee is not established, charged, or received by a payment card network. The Board has added paragraph 2(j)-3 to the commentary to explain that fees set by an issuer, but charged by a payment card network are considered interchange transaction fees for purposes of this part. The Board plans to monitor whether collective fee setting is occurring and whether it is necessary to address collective fee setting or similar practices through the Board‘s anti-circumvention

Part 2 – “Unprofitable” Payments

Yesterday’s post was “Banks will win in Payments”, a general rule of thumb that had one major caveat: Payments which are profitable. What about payments which are not profitable?

January 31, 2011

Yesterday’s post was “Banks will win in Payments”, a general rule of thumb that had one major caveat: Payments which are profitable. What about payments which are not profitable? Primary examples:

Historically Checks and Cash were a cost of doing “bank business”. Debit cards proved to be the most successful product in converting cash and checks into electronic payments (see Cash Replacement). Recent US financial legislation will move the debit business into a break even business for banks.. from 120bps of the transaction to a flat fee of $0.12. This has caused Banks to take a hard look at the “payment business” to determine if and how they make continued debit investment. Why support a Visa/MA branded debit card at all? Austrailia, Canada, Japan and Germany have similar dynamics here.. if you go to Canada and pay with “debit” it is your Interac card.. a bank owned debit network.. which retailers prefer as their payment mechanism of choice. In these geographies Visa and MA are known for Credit transactions only.

Clearly “payments” are a necessity for every transactional account (Demand Deposit Account – DDA). As US retail banks attempt to adjust DDA account fees, to rebalance overall product profitability, there are new alternatives developing that present a much more cost effective value propositions, particularly for segments below the mass market. Low value payments can support and even enhance existing value propositions of other non-bank networks, a dynamic I described in Why MNOs will Rule in Emerging Markets. As such, we are beginning to see “fragmentation” within “low value” payment solutions. In the US carriers are developing partnerships with mobile billing solution providers (Boku, billtomobile, …). In model, carriers are taking on some additional “credit risk” but are starting off small with digital goods. Low value payment further enhances the overall consumer value proposition for the mobile operator (retention, network use, network effects, on us, …).

Top Tier Banks must tread carefully on DDA fees, not only do they face competition from credit unions (not impacted by the interchange fee limits), and MNOs but also from pre-paid cards and brokerages which provide much of what mass consumers need in transactional accounts. The downside for mass market consumers is one of credit. Banks make credit decisions based upon relationship, credit history and DDA records. Keeping your balances out of a top tier bank (or the banking system) will make it harder to get a loan. As comments are coming due on the Dodd-Frank amendment.. a key bank argument is that the regulation will indeed create more unbanked.

Part 3 will cover new models where ad spend replace interchange in driving payment system revenue.

Message for start ups.. payments are a mine field.. the new debit interchange rates will drastically reduce merchants costs. Be cautious in building solutions around existing debit networks.. banks are planning changes.

Decoupled Debit

Retail Payments over the next 20 years are likely to morph substantially from their current issuer/network dominance. In addition to regulatory changes, new technologies and new value networks are creating a new competitive dynamic which will bring more than $5-10B in capital investment into the payments within the next 2-3 years.

8 November 2010

Winston Churchill may have been referring to Payment systems in the US when he said:

It is a riddle, wrapped in a mystery, inside an enigma

The macro economic impacts of the recent US card legislation portend substantial business change for Visa and Mastercard. The US debit card market is soon to resemble Australia and Canada with other countries soon to follow (See China and India). Retail Payments over the next 20 years are likely to morph substantially from their current issuer/network dominance. In addition to regulatory changes, new technologies and new value networks are creating a new competitive dynamic which will bring more than $5-10B in capital investment into the payments within the next 2-3 years.

My wife’s visit to Target this week prompted a revisit to the decoupled debit space. Target’s value proposition: hand me your check and sign a release form, you will then receive a RedCard linked to your checking account and good for 5% off all future purchases. Will we see more of this type of value proposition (which Durbin enables through its steering provision)?


Decoupled debit is interesting for several reasons:

  1. The issuer is not required to be a bank in order to offer an account and issue a card
  2. The products can exist as private label products or co-branded products
  3. The products can potentially build significant loyalty
  4. The products reduce costs when delivered and managed correctly
  5. The products leverage the existing payments infrastructure and standards

Retail Business Case

Retailers have a different mindset when it comes to alternative or decoupled products because they are stakeholders in the product, not just the transaction. They look at the product as a way to help them:

  • Reduce cost of payments
  • Build loyalty
  • Offer merchant-designed promotions
  • Drive more store sales
  • Segment and target customer groups
  • Leverage ‘spend information’

For those outside the US I recommend reading:

Debit Card in Peril?

The biggest story of the week has largely gone unreported. Bank of America (BAC) has taken a $10.3B goodwill impairment charge in 3Q. What does this mean for Visa? Not Good News.

27 October 2010

The biggest story of the week has largely gone unreported. Bank of America (BAC) has taken a $10.3B goodwill impairment charge in 3Q.

The Merchant Payments Coalition responded to the impairment charge (reference above)

“With a Federal Reserve decision on debit interchange rates not expected until mid-2011, today’s claims by Bank of America dramatically overstate reality and represent a feeble attempt to divert attention from its mortgage foreclosure problems,” said Doug Kantor, counsel to the Merchants Payments Coalition.

In the 8-K, Bank of America said it plans to take (ref The Street)

 “a number of actions that would mitigate some of the impact when the laws and regulations become effective,” but it didn’t provide details about what those actions might be.

Will write more later, but I can assure you BAC is looking for debit alternatives. Given their size, most anticipate a new product driven from both their retail and global card team (including merchant services). So in addition to AT&T/Discover, we will now have another major bank led team developing a new payment product with a multi billion dollar incentive.

What does this mean for MA and Visa? Not good news for US growth.

Related Article

Ruminations: Durbin and Debit

Time for a blog with many questions and few answers. My natural perspective is that of a banker. Banks are created to act as trusted intermediaries of commerce, and I’m concerned when their ability to act on this charter changes. I want banks to win and to create products that satisfy the customer, build trust, and effectively serve in commerce.

Will Merchants loose sleep if debit goes away? Answer probably rests with what will take its place.

13 Aug 2010

Time for a blog with many questions and few answers. My natural perspective is that of a banker. Banks are created to act as trusted intermediaries of commerce, and I’m concerned when their ability to act on this charter changes. I want banks to win and to create products that satisfy the customer, build trust, and effectively serve in commerce.

A friend and I were discussing the impact of Durbin’s 2 tier debit structure (Excellent analysis by Mercator here) on the incentives for large banks to continue to issue debit. My perspective (as a banker) has been greatly altered from my time at 41st parameter working with the largest retailers in the world. I’ve developed a new view and a new appreciation for the pain felt by merchants. It would not be too extreme a statement to say that there is a deep hatred of the cards networks. The feeling is both visceral and reasoned. I remember when a senior executive from Wal*Mart came to Wachovia for a presentation and was asked what he thought were appropriate interchange rates for credit and debit. He said “0” dead pan.. then during the quiet of the audience, he said “actually we think we should be paid for accepting your cards” and emphasized that this was not a joke.  

Will Merchants loose sleep if debit goes away? Answer probably rests with what will take its place. The retail banks are very unorganized around payments. With few exceptions (Chase, WFC, USAA, ..) bank payment executives do not get the focus of their retail organizations.  In general, retail banks are challenged to relate payments to profitability (and hence the overall retail strategy). Debit was a clear exception to this challenge and a “killer product” for cash/check replacement.

The bank value proposition for debit was clear. However, what was the merchant value proposition? Certainly reduction in check fraud, funds availability… but at what costs? The federal reserve studied interchange rates in graph to the right. What exactly drove this step creep? How did it drive value? What were the economic forces that pushed back against it? What additional investments did Visa/MA make in their network?

Will banks develop a debit replacement? Clearly Durbin has reduced banks incentives to push debit (w/ assets over $10B). I project that the market is ripe for a merchant friendly payment method that is much different than the products available today. Instead of funding the card product on merchant interchange.. perhaps mobile advertising?

Can banks/cards regain the trust of merchants as intermediaries of retail commerce? Could the wholesale or merchant acquisition business which drives a new payment product (ie Amex Revolution Money)?

 Thoughts appreciated