Thursday, June 15, 2006

"Bracing for Change to Banks' House of Cards" (The Green Sheet)

A convergence of events, in the United States and abroad, is threatening the bankcard industry's interchange cash cow. Any doubts I had about this were eradicated during NACHA - The Electronic Payments Association's Payments 2006 conference. This year, the event featured a string of sessions on cards, and folks attending had interchange on their minds.

Here's how Duncan MacDonald, former Citibank General Counsel turned consultant, described the current situation: "Clearly, the card industry is in deep, deep trouble. It's under siege here and around the world."

MacDonald's comments came a week after the Reserve Bank of Australia announced reforms to debit card rules that bear a strong resemblance to rules it imposed on credit card schemes in 2003.

Those rules forced Australian banks to slash interchange on Visa International and MasterCard International credit card transactions and eliminated the Associations' surcharging prohibitions.
The Reserve Bank's latest reforms, to take hold in November, slash by two-thirds the current gap between Visa's higher POS debit interchange rate and the rates assessed by Australia's homegrown
EFTPOS system.

Additionally, the Reserve Bank has ordered Visa to eliminate rules that force retailers accepting Visa credit cards for payment to also accept Visa debit cards. Plus, it capped the fees charged for connecting to the Australian EFTPOS system.

The Reserve Bank decided to force down debit interchange rates because of its belief that the current interchange structure creates "a strong incentive" for financial institutions to promote Visa's POS debit cards over the lower cost Aussie EFTPOS system.

"The reforms ... will narrow the current 60-cents difference in interchange fees to around 20 cents," the Reserve Bank stated. "By significantly narrowing the difference in these fees, these reforms will promote competition between the schemes based on the benefits that they offer to cardholders and merchants, rather than on fees that are not subject to normal competitive pressures."

Interchange works differently in Australia than it does in the United States. When POS payments clear through the Aussie EFTPOS system the bank that issued the card pays about A$0.20 in interchange to the merchant's bank.

In contrast, if a Visa debit card is used for a POS debit payment and cleared through the Visa network, the merchant acquiring bank pays the card-issuing bank an average A$0.40 in interchange.

Under the new pricing scheme, the fees paid by issuers for each transaction cleared through the Australian EFTPOS will drop to something in the range of A$0.04 to A$0.05. Interchange paid to Visa debit issuers in Australia has been pegged at about A$0.15 per transaction; down from the current A$0.40.

Will the United States follow Australia?

The Reserve Bank is Australia's central bank. But unlike the U.S. Federal Reserve Bank, the Reserve Bank has direct regulatory authority over payment card schemes, and that authority extends to pricing.

In the United States, individual card brands, such as Visa and MasterCard, set interchange fees. The Fed's job with respect to payment cards is to develop and help ensure compliance with consumer protection laws, such as the Electronic Funds Transfer (EFT) Act, nothing more.

In 2003, the Reserve Bank slashed interchange on Visa and MasterCard credit transactions and threw out the Associations' no-surcharge rules, an action that the bank reported shaved A$580 million off retailers' combined interchange tab. Ever since, the specter of similar action has hung over the U.S. bankcard industry like an ominous cloud.

In the past, the Federal Reserve has declined to regulate card interchange, saying it doesn't have the authority. But that was when Alan Greenspan was Fed Chairman. Ben Bernanke, the Fed's new Chairman, hasn't yet weighed in on the matter, and some experts believe it could be time for a policy change.

Plus, it's an election year. Congressional incumbents are on the lookout for legislative causes that play well with consumers, and this could be an issue that attracts voters. The connection between electioneering and legislating cannot be underestimated.

Most major banking legislation enacted over the last 50 years was passed during election years. (Two examples: the EFT Act and the Expedited Funds Availability Act, which set limits on check holds.)

Mallory Duncan, General Counsel at the National Retail Federation, believes a case can be made for federal regulation of interchange. He pointed to the Federal Reserve Act, early 20th century legislation that created the Fed as a means of stabilizing the economy.

Prior to this law, banks were allowed to deduct fees from the face of checks to cover risks and other costs. One of the Fed's first jobs was to eliminate this process of paying on checks. Duncan believes this same argument (of treating card payments on a par with one another) can be applied to today's market.

And let's not forget the pending lawsuits against Visa and MasterCard that challenge interchange. Most of the lawsuits have been combined into one class action suit now pending before a federal court in New York.

MacDonald predicted the Fed will be pulled into the fray. "I believe they have the authority," he said. "I think this case is such a monstrosity that [the presiding judge] would be happy to have regulators step in."

Then, referring to the Fed's 2005 decision not to address the issue, MacDonald contended, "Alan Greenspan was wrong. If this thing blows up they [the Fed] will have to fix it."

J.D. Denny Carreker, a long-time consultant to banks and Chairman and CEO of Carreker Corp., a software and consulting firm, urged bankers attending NACHA's conference not to let the Fed become involved in such matters. "In my view, the Federal Reserve does not have the knowledge you and your customers have," he said.

The big question now is, will Visa's and MasterCard's recent actions to restructure their boards be sufficient to keep Congress and regulators at bay?

[Source, The Green Sheets, written by Patti Murphy, Senior Editor of The Green Sheet and President of The Takoma Group].