Banks are looking beyond consumers to Visa Inc. and MasterCard Inc. to share the pain of lower interchange fees.
Analysts say they expect debit card issuers to pressure the payment networks to lower the fees they charge banks for their services in response to a pending reduction to interchange rates.
So-called network fees are what Visa, MasterCard and other card networks charge the banks that issue cards with their logos. The fees cover transaction processing, licensing, overall network maintenance and other costs.
Such fees are separate from interchange rates, which the networks set but issuing banks collect, through acquiring banks, from merchants when consumers use debit cards. It is those rates that the Federal Reserve Board has proposed cutting by as much as 90%, according to some estimates, in accordance with the Durbin amendment of the Dodd-Frank Act.
Visa and MasterCard executives have said concerns over their network fees are overblown, since network fees are negotiated separately from the process of setting interchange rates. But some analysts disagree.
"You can't say there's no relationship," said Eric Grover, a principal with the payments consulting firm Intrepid Ventures in Minden, Nev. "You have a product and a set of services with a stream of associated revenue. If they dramatically change — as they are now — how your licensees think about it is also going to change. I think that's cut and dry."
At a Keefe, Bruyette & Woods Inc. conference in New York last week, executives from Visa and MasterCard said their fees are justified by the services they provide, even if banks are no longer able to earn as much interchange revenue.
"There's lots of speculation around our fees and what it means for us," said Bill Sheedy, the group executive for the Americas at Visa. "Nearly all of the dialogue with the banks is around understanding what the business looks like on the other side of this, trying to help them with consumer research and information, strategizing around product evolution and repositioning of payments."
He added, "I'm not saying that there won't at some point be contractual elements to it, but we're much more active with them on portfolio optimization and expansion of the product set."
Payment networks charged issuers $2.3 billion in fees in 2009, according to the Fed's written proposal for implementing the Durbin amendment.
Analysts they agree they are likely to come down as banks look for ways to recoup their costs, though they have not projected how much they expect the fees to decline.
Many banks already are raising minimum balance requirements that customers must meet to avoid monthly checking account fees, raising those fees outright and considering new fees tied to debit card use. Such actions represent a more immediate way for card issuers to cushion their revenue losses than does pushing payment networks to lower their fees.
That's partly because the network fees they pay Visa and MasterCard are subject to longer-term contracts and are negotiated when agreements approach expiration. Many large issuers, like Bank of America Corp. and JPMorgan Chase & Co., also exert significant bargaining power as things stand because they have a large customer base, so there may not be as much ability to extract major price concessions, experts said.
"The big debit card issuers already get very attractive pricing from Visa and MasterCard even in the pre-Durbin world," said Jason Kupferberg, an analyst who follows the payment networks for UBS Securities LLC in New York. "I'm not suggesting that there's zero potential for downward pressure. I'm just saying in the scheme of opportunities … there's going to be more significant opportunity to introduce new fees on the consumer side as opposed to … squeezing a lot more" from the networks.
Complicating the issue is a Fed proposal to prevent networks from trying to compensate for lower interchange by drastically lowering their own fees to issuers while raising fees they charge to merchants' banks.
Networks charged those banks, or merchant acquirers, $1.9 billion in fees in 2009, according to the Fed's proposal.
Grover said this provision is relatively benign, as it means that fees that issuers pay networks (net of any rebates they receive from networks for meeting payments volume thresholds and other factors) cannot be less than zero.
But with the Fed proposing to cap debit interchange fees at 12 cents per transaction, compared with a current average of 44 cents, it is difficult to see how networks will be able to command existing fee levels, said Chris Brendler, a managing director with Stifel, Nicolaus & Co. Inc.
Brendler said that initially he thought Visa and MasterCard faced little risk of having to lower their fees because he did not expect the Fed to propose as low of interchange caps as it did.
Since the Fed issued its preliminary rules in December, Brendler said his thinking has changed.
"Basically now the banks are break-even under the 12-cent cap on interchange" not counting what they pay Visa and MasterCard, Brendler said. "I now think those fees would have to come down as long as the Fed proposal comes through as is."
Chris McWilton, the president of U.S. markets for MasterCard, said it is not "a fair assumption" that its network fees would fall by an amount corresponding to reductions in debit interchange. "I think the whole discussion with the network economics is a little exaggerated, personally," he said.
MasterCard has contracts in place with most of its major debit card issuers that typically range three to five years, McWilton said. "They do not have clauses in there which attempt to link interchange economics and network economics," he said. "In fact, we have been quite adamant with our contract negotiations that we are not going to guarantee … network economics on our deals."
McWilton added, "There is no doubt that when those contracts come up for renewal the competition will be as fierce as it is today but that's something that is in the distance."
