New Swipe Dynamics

With debit-card interchange-fee reform, will consumers turn to alternative forms of payment?

COCONUT CREEK, Fla. -- Despite the recent news that Tempo Payments Inc. would cease operations, ending the decoupled debit network services it offered to QuikTrip Corp. (click here for previous CSP Daily News coverage), the decoupled debit model is alive and well, according to Joe Randazza of the National Payment Card Association (NPCA), [image-nocss] a marketer of automated clearing house (ACH) decoupled card-based payment systems.

San Mateo, Calif.-based Tempo enabled retailers to offer affinity and co-branded debit cards to its customers, providing retailers a lower-cost alternative to Visa and MasterCard. The open-loop cards it offered are rewards based, partner branded and linked to the consumer's existing checking account.

The Tempo business model was signature-based debit, Randazza told CSP Daily News; NPCA is a PIN-based product. "In today's current environment [for signature], there is a floating rate of something like 1.35% of the tendered price versus PIN debit being something in the area of 70 basis points and 13 cents."

He added, "A [$40 gasoline purchase] in a PIN-based environment under current interchange prior to Durbin would be 41 cents. A $40 transaction in signature in the current environment would be around 55 cents because signature is a floating percentage rate that is higher than PIN."

Tempo was a Discover-issued product that was trying to capitalize on the existing interchange structure for the purposes of generating revenue, he said. NPCA's model is to offer products that displace those types of products to reduce a retailer's interchange expense.

"The industry may have a viewpoint decoupled debit is not going to be an option to help them find a lower cost of settlement, when--in fact--PIN based decoupled debit, because of the Durbin Amendment, is actually prospering," said Randazza. "PIN debit is going to prosper under the regulations. Merchants will continue to benefit from having a cheaper value than even the regulated rate of 24 cents. Our rate is 15 cents."

Tempo is blaming the Federal Reserve Board's new debit-card regulations for its demise, reported electronic payments publication Digital Transactions. The company said that the regulations will cut its revenues in half.

"We are a casualty of the Durbin Amendment," Tempo CEO Mike Grossman told the publication concerning the section of 2010's Dodd-Frank Act that ordered the Fed to set price controls on debit-card interchange and lift issuer and network restrictions on merchants' freedom to route debit transactions as they see fit.

The financial institution that holds a customer's demand-deposit account (DDA) does not issue the Tempo debit card. Instead, the card uses the payment card network for authorization and settlement with the merchant acquirer, but debits the DDA via the automated clearing house for settlement with the cardholder. It generates revenue based on the interchange rates of the card network over which the transaction is routed. Tempo would oversee the process, splitting the revenue between the issuer, merchant and itself.

A heavy reliance on interchange proved to be Tempo's undoing, Patricia Hewitt, director of the debit advisory service at Mercator Advisory Group, told Digital Transactions. "You can't cut 50% of the revenue stream and continue to operate," she said.

According to Grossman, Tempo got 44 cents in gross revenues per transaction.

The Durbin Amendment exempts from interchange regulation debit-card issuers with less than $10 billion in assets as well as general-purpose reloadable prepaid cards and government debit cards. The Fed specifically did not exempt decoupled debit cards with transactions routed over payment card networks.

"An issuer of a decoupled debit card is not exempt... even if, together with its affiliates, it has assets of less than $10 billion, because it is not the entity holding the account to be debited," page 323 of the draft final rule says, according to the publication.

"They singled out decoupled debit card issuers," Grossman said.

Click hereto read the full Digital Transactions report.

Randazza said that while the new regulations have "knocked out their income stream" for Tempo, NPCA "has been operating under that 15-cent income stream--we've been 'swipe-fee reformed'--since 2004. ... Our cost structure has always been built around that."

The impact on consumer payment preference of adding transaction fees for using debit cards is dramatic, and a recent Mercator white paper sponsored by NPCA suggests that a large majority of consumers will stop using their debit cards and instead switch to paying with cash or other forms of payment.

With the rise of debit cards as a preferred payment method, financial institutions have embraced debit cards as an account acquisition and retention strategy as well as a means of migrating more expensive forms of payment to more efficient, electronic transactions. As a result, the cost of acceptance has risen, creating a backlash. Merchants have pursued legal and regulatory relief, culminating in the Durbin Amendment to the Dodd-Frank Act. For the first time, U.S. debit-card interchange fees will be regulated, and the industry is facing a "new order where legacy business models will be left behind and new ones will take their place," the white paper said.

To understand the impact these new business models may have on the market, Mercator surveyed consumers to determine payment preferences, demographic influences and the effect fees and rewards have on everyday purchase payment decisions at the point of sale.

The Durbin Amendment included new regulations that give merchants the option to discount payment tender types, require issuers to participate in multiple debit-card networks and set minimum and maximum thresholds that can be put into place for credit-card transactions. At the same time, consumers are feeling the pressure of having less disposable income.

When asked which payment tender type consumers preferred to use when purchasing gasoline, groceries and drug store items--other than at gas stations, where credit was the preferred payment method--debit was by far the payment form of choice, the report indicated.

If consumers are faced with monthly fees, those who indicated they would switch payment forms chose cash above all other payment forms, regardless of the store type, the survey added (see chart).

Should consumers turn to cash to pay for gasoline, it is more likely that they will purchase less gasoline at any one given time because to a reluctance to carry large amounts of cash, and they may also have less cash left over for discretionary, convenience purchases such as drinks and snacks, said the survey.

The Mercator research indicated that the option to use a decoupled debit card carrying the merchant's brand is "very attractive" to consumers.

Click here to view the full white paper.

Maynard, Mass.-based Mercator is an independent research and advisory services firm exclusively focused on the payments and banking industries.

NPCA, based in Coconut Creek, Fla., offers retailer-branded debit cards.

(Click here for previous CSP Daily News coverage of the interchange fee issue.)