The Durbin Amendment to the Dodd-Frank financial reform act will likely cut credit union debit card income in the short term but may also spur further innovations in the payments industry.

Those are among the conclusions of two recent reports that looked at the likely impact of the debit interchange reduction that the Durbin Amendment mandated. “The New Order: How Interchange Regulation Will Change the U.S. Payment Industry,” published by the Aite Group and “Interchange Regulation: Implications for Credit Unions,” published by the Filene Research Institute considered the impacts of what their researchers considered the most likely Federal Reserve regulations.

Under the terms of the amendment, the Federal Reserve has to publish regulations that will limit debit card interchange for issuers with more than $10 billion in assets. The precise impact of the new regulations will not be clear until they are published, but the legislative mandate was for the Fed to only consider “reasonable and proportional” costs of debit card issuing in its calculations. Observers have said that the cost of fraud may be included in the regulation, but the cost of overhead and marketing may not be.

The New Order report makes 14 predictions on what the likely impact of the interchange regulations will be as well as which parts of the payments industry will be most likely to benefit or lose from the regulation. The Interchange Regulation report looks more narrowly at the regulation's impact on credit unions.

Sen. Richard Durbin (D-Ill.) included the $10 billion limitation for the new regulations in an attempt to win the backing of both credit unions and community banks, essentially offering them protection from the act's total impact, which he intended to focus on large banks.

But both reports pointed out that the amendment will not likely succeed in that goal because differentiating between card issuers by size will be beyond the ability of many merchants and because the law leaves room for merchants to choose payment networks that will not pay as much to issuers.

“Though larger retailers will be sophisticated enough to use BIN tables to decide what to pay which banks, millions of merchants won't have the level of sophistication required to enforce the exemption rule,” Aite wrote in its report.

The organization also said that small debit card issuers will “lose revenue when merchants use least-cost routing for debit switching and steer customers to lower-cost payment methods. Depending on how the regulation is implemented, they might be unable to benefit from the exemption and instead become collateral damage.”

Likewise, the Filene report makes a similar point. “Institutions with less than $10 billion in assets may be shielded from the 'reasonable and proportional' interchange standards, but they will still be subject to 'multi-homing'-the requirement that each card be capable of processing a transaction on more than one network,” wrote report author Adam J. Levitin, an associate professor of law at Georgetown University Law Center in Washington, D.C. “Competition among networks will allow merchants to route transactions to the network that saves them the most money, which will push down income for issuers,” he added.

But beyond the impact to interchange income, both reports discussed some of the other changes that the firms said are likely to come about because of the new interchange rules.

For example, the new regulation may do a lot to revive regional PIN-debit networks that have been losing ground for years to national PIN-debit networks. This would be because the new regulation prevents debit issuers from establishing their debit networks in a way that maximizes their income. In effect, Aite pointed out, this will limit the reliance on Visa's networks.

“At a minimum, the law is putting a stop to years of Visa's gaining market share in PIN debit,” Aite wrote. Visa will no longer be able to sign exclusive deals with debit card issuers for its Visa signature debit network and Interlink PIN debit network. Banks will not be able to switch debit card transactions exclusively through Visa, the report said.

This will increase demand for other networks, such as Star Systems (owned by First Data), NYCE (owned by FIS) and PULSE (owned by Discover), Aite added.

Levitin forecast that market pressures will also lead debit networks to adopt a two-tier interchange system and schedule to keep transaction volume from smaller debit issuers.

“It is unlikely, therefore, that networks will adopt single-tier pricing,” Levitin wrote. “Instead, the networks are likely to move to separate pricing for small issuers because if one network does and the others do not follow, that network will gain significant market share by aggregating the business of numerous small issuers.”

Significantly, both reports predicted that the new regulation will drive some additional innovations in the payments industry. The Aite report estimated that banks will increase their offerings of prepaid cards to help avoid or mitigate the debit interchange cut. They may also begin to shift their debit card marketing to where they will try to establish more relationships with merchants to increase debit traffic.

Also, both groups reported that the debit interchange cut may well end up bringing chip and PIN cards to the U.S. market.

Chip and PIN cards rely on an embedded microchip for the card security and have thus been seen as more difficult targets of card fraud.

The reports considered chip and PIN cards more likely after the interchange cut because the Federal Reserve was almost mandated to write regulations that would require them in the law. In addition, Aite pointed out that adopting chip and PIN would move much of the responsibility and expense for card fraud prevention to the merchants and that cutting the interchange income from debit transactions that are authorized with a signature had removed one of the last reasons card issuers had for keeping magnetic stripe cards over those with chip and PIN.

Instant Insights /

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