Durbin 2 – Short Update

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What are the new Durbin’s legislative prospects? A: Not at all likely (<10% probability)

Top retailers spent this week meeting with Bank CEOs trying to convince them to support the new Durbin legislation. Their pitch was to enable bi-lateral deals, “new products” and avoid network rules (see blog). Banks did not seem to bite, as they remembered the lessons of Durbin 1:

  • Only largest merchants benefited from dual routing
  • Consumers lost in debit rewards (ie keep the change), increased bank account fees, and no merchant pass-through of savings
  • Acquirers/processors did not pass through fee reductions to most merchants
  • Networks recovered lost revenue through merchant fees
  • Large banks lost competitive advantage as smaller “exempt” banks under $10B operated under different rules
  • See WSJ article

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Driving Vision of Durbin? Bi-Lateral Connections?

My latest G2 from people involved in shaping Durbin is that retailers see an opportunity to end-run networks in bilateral deals AND direct (alternate) routing. To be clear, issuers have always been able to strike bilateral deals directly with a merchant. What they have not been able to do is route these transactions off-network. 

I now have 70% confidence in the forces shaping Durbin (still no threat to V/MA). 

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Durbin 2 – Impact on “Wrapping” Rules?

A highly technical “what if” scenario involving a long-sought after change by top US card issuers. What if Durbin credit routing bill were designed to eliminate network wrapping rules?

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A highly technical “what if” scenario involving a long-sought after change by top US card issuers. I’m fortunate to have the exec teams of just about every payment network, processor and FinTech read this blog. I have 3 main drivers for writing today:

  1. Start a community discussion
  2. Assess the potential for a much more strategic driver behind the proposed Durbin bill
  3. Most “change” in US payments is driven by 7-10 players: networks, top issuers, Google, Apple, … etc. These changes have an enormous impact on the FinTechs building around them. I’m hoping to help these small companies plan around these changes as the only advantage of a start is speed.

Note I DO NOT think this scenario is likely, but rather possible (30% probability). Historical context is key and the only reason I’m spending time on this today is that 27 bank CEOs have been discussing this for over 10 yrs.

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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.

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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.

http://www.bai.org/bankingstrategies/payments/general/protecting-dda-profitability

http://www.novantas.com/article.php?id=317

http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245235038776

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.

Future

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).

Pre-Paid

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