The U.S. interchange battle between merchants and issuers is coming to a close now that the Durbin Amendment has been interpreted by the Federal Reserve Bank.
What's left has the industry scrambling for compliance. Large debit card and prepaid card issuers are already grieving over significant losses in revenue and the added expense of making it all work. The merchant community has largely prevailed, but not to the extent that it had hoped, given that the interchange rate cap was set at a higher level than was originally anticipated. In general, merchants persevered, however, and have become the major force in the routing of debit-based transactions.
Large banks, issuers, and networks have been stripped of their ability to set debit card interchange fees as they please. Prepaid issuer interchange rate cap exemptions will prevail for organizations with assets of less than $10 billion. Large banks that issue general purpose reloadable prepaid cards will have to make key decisions about how they manage these portfolios. On the surface, the outcome is somewhat neutral for credit unions, but opportunities exist to benefit from others' losses.
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Large issuers in particular will see an $8.3 billion annual revenue shortfall from the rate cap. It is worthwhile to note that the top 50 U.S. debit card issuers (all organizations with assets of more than $10 billion) enjoy 80% of the interchange revenue. That leaves 20% with the smaller organizations. That number is projected to be $3.5 billion in 2012. Aite Group expects the ratios to shift once the interchange rate cap is in place. There is a good possibility that a larger portion of the interchange revenue will move to the smaller issuers.
Ironically, it is consumers (the very group the amendment claimed it sought to protect) who are the biggest losers. They will be adversely impacted as banks hike checking account fees, eliminate some banking features, and exit some markets all together in an effort to recoup lost revenue.
This is where an opportunity for credit unions and small issuers may exist. Organizations that step up efforts to expand debit card and reloadable prepaid offerings can capture some of what the big issuers are losing. Those credit union organizations that put the right strategies in place can capture a greater share of the demand deposit account market as the large banks hike fees. These credit unions have an opportunity to acquire more consumer relationships in general from those that are disenfranchised from large banks. Large banks will hike fees and reduce features across the board on DDA and reloadable prepaid products.
As large merchants and acquirers implement least-cost-transaction routing systems, however, small issuers that are exempt from the Durbin Amendment may not be able to preserve higher interchange rates, given that issuers as a group have no influence on transaction routing.
On the other hand, small issuers can benefit from the revenue derived from adding balances and more accounts in their DDA portfolios. Small issuers should make a concerted effort to advertise for DDA business targeting the customers of large banks. Credit unions' marketing strategies should tout price and the personalized service a credit union can offer. It will also be important to address any potential convenience issues that are perceived as a negative. These issues maybe centered on the number of branches and ATMs, as well as location proximity to prospective customers.
Other opportunities for credit unions exist in relation to the inability of small merchants to be able to take advantage of least-cost-routing techniques deployed by the large merchants, thereby preserving the higher interchange fees going to the exempt issuers. Exempt issuers may have an opportunity to partner with large, non-exempt banks to offer a co-branded prepaid product. In this situation, the exempt party could be the "issuer" of the card on behalf of the larger organization. The larger credit unions may be able to support this type of effort and create a new line of business.
Credit unions and other small institutions should band together to ensure that Visa and MasterCard maintain tiered interchange pricing structures on all card types. They can also work together with processing organizations to appeal to networks.
In summary, there is opportunity for credit unions in the changing marketplace. Of course, just how much they are able to capitalize on that opportunity depends on their ability to preserve margins and capture new business. Some interchange margin preservation will be beyond their control, but opportunities exist in building DDA relationships with new consumer prospects.
Madeline Aufseeser is a senior analyst with Aite Group.
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