The Federal Reserve Board's proposed debit card interchange rules would slash issuers' revenue by $11.8 billion, cutting large issuers' debit card revenue by 73% per transaction on average and making debit cards "significantly unprofitable," a report says.
The proposed rules may leave issuers with assets of less than $10 billion unaffected, but the nation's largest banks — which depend more heavily on the $16.2 billion in revenue debit cards generate annually — would have to change their product offerings and prices to make up for the lost income, according to Tony Hayes, the Oliver Wyman Group partner who wrote the Dec. 22 report.
The Fed's proposed rules, included in the Dodd-Frank Act, also would prohibit payments networks and issuers from limiting the number of transaction-routing options on a debit card to a single payment brand's network or to two or more affiliated networks.
"The proposed regulation will have massive and far-reaching consequences for retail banks," Hayes wrote in the report. "The new economics associated with operating a debit card portfolio are likely to lead to fewer rewards programs, more consumer fees and a different set of banking choices."
Banks earn approximately 44 cents per debit card transaction, for an average of $87 in annual revenue per active card, Wyman's data shows. Under the Fed's rules, those numbers would drop to about 12 cents per transaction and $24 in annual revenue per card.
For a typical $40 PIN-debit Interlink purchase, the interchange fee for retail merchants ranges from 30 cents to 45 cents, depending on volume, while the interchange on a $40 Visa check card signature-debit transaction ranges from 37.8 cents to 56.8 cents, according to calculations using Visa Inc.'s published rates. Visa controls about 80% of the signature-debit market, the more profitable of the two types of debit card transactions.
Debit card transaction volume grew 18% a year on average from 2000 to 2009, reaching 37.9 billion transactions last year and representing 35% of all noncash retail payments, according to Wyman.
Revenue from debit card transactions provides the "economic foundation" to offer mass-market free checking services, Hayes wrote.
If the bulk of that revenue disappears, banks would be compelled to restructure their core products and begin charging consumers fees for consumer checking accounts and other products, he wrote.
The proposed rules' restrictions on banks' affiliations with debit card networks could create "even greater upheaval" by forcing banks to partner with new debit card networks by Oct. 1, Hayes wrote.
A report from Mercator Advisory Group Inc. in Maynard, Mass., said that the Fed's two network-affiliation proposals would stir up competition in the network market.
One proposal calls for issuers to operate on two unaffiliated networks without consideration of the authorization method chosen by the cardholder.
For example, issuers would offer one network for PIN-debit transactions and use an unaffiliated network for signature-debit purchases, Patricia Hewitt, director of debit advisory services at Mercator, wrote in her report, "The Durbin Amendment: A First Analysis of the Draft Rules."
The other proposal is to offer two unaffiliated networks for each authorization method, Hewitt's report said.
There are no exemptions from the affiliations rule, Hewitt wrote. Networks "have been both discrete and bold in their market strategies to date, but this should help them take their gloves off and begin to compete in earnest for issuers," she wrote.
Moreover, networks will have to compete on value, because interchange fees will be flattened, Hewitt wrote.
"Those networks that have made investments in infrastructure to support more-flexible programs, better reporting, fraud control and operating efficiencies should be able to quickly take a more-leveraged position," she wrote.
Hayes at Oliver Wyman recommended that banks submit comments on the proposed rules before the Federal Reserve's Feb. 22 deadline.
The rules are slated to go into effect July 21.
