Oliver Wyman Report Finds $11.8 Billion of Debit Interchange Revenue Could Disappear Based on Proposed Draft Rules for Durbin Amendment
NEW YORK--(BUSINESS WIRE)--In the US banking industry, $11.8 BN of the current $16.2 BN generated in debit interchange revenue will disappear from the system, according to a new Oliver Wyman report titled, The US debit Market and the Durbin Amendment: Worse than the worst case scenario. Based on the proposed draft rules announced by the Federal Reserve on December 16, 2010, debit interchange revenue for regulated card issuers will decline by 73%, from an average of $0.44 per transaction today to, at most, $0.12 per transaction, as of July 21, 2011. With the new rates set in reference to a sub-set of all debit card costs, the economics of debit card programs will become significantly unprofitable.
“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.”
Between 2000-2009, debit has grown at an average annual rate of 18% and is now the most commonly used non-cash method of payment. In 2009, there were 37.9 billion debit card transactions performed in the US, representing 35% of total non-cash retail payments. Currently, card issuers generate an average of $87 of revenue per active consumer debit card per year, but starting on July 21st, for banks with at least $10 BN in assets, this figure will drop to $24 per year.
Card issuers with less than $10 BN in assets may also be affected, as there is no provision that requires debit networks to set different interchange rates between large, regulated card issuers and small, exempt card issuers. The Oliver Wyman report states that if debit interchange revenue for smaller issuers does decline, the result could be severe; not only will these programs become highly unprofitable, the very viability of some community banks and credit unions will be threatened.
Interchange revenue from debit cards provided many banks with the economic foundation to support free checking for mass-market customers; without this revenue source, financial institutions are likely to implement a range of direct-to-consumer fees.
In addition to price regulation, the proposed debit rules place certain conditions upon banks’ affiliations with debit card networks. A number of large banks will be required to partner with new debit networks by October 1, 2011, with the potential for even greater upheaval.
“The proposed regulation will have massive and far-reaching consequences for retail banks”, said Tony Hayes, Partner at Oliver Wyman Financial Services and author of 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.”
The Oliver Wyman report recommends banks do the following: (1) restructure their core debit card business (2) re-price and reposition the underlying demand-deposit accounts (DDAs) and associated payments businesses, and (3) submit commentary on the draft proposed rules before the Federal Reserve’s February 22, 2011 deadline.
For a copy of the Oliver Wyman report, The US debit Market and the Durbin Amendment: Worse than the worst case scenario, please go to www.oliverwyman.com/ow/ow_durbin-amendment-debit-market.htm
About Oliver Wyman
With more than 2,900 professionals in over 40 cities around the globe, Oliver Wyman is an international management consulting firm that combines deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation and leadership development. The firm helps clients optimize their businesses, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is part of Marsh & McLennan Companies (NYSE: MMC). For more information, visit www.oliverwyman.com.
The US Debit Market and the Durbin Amendment
Worse Than the Worst-Case Scenario - What Banks Need to Do Now
On December 16, 2010, the Federal Reserve released its proposed rules to regulate the US debit card market, as required by the “Durbin Amendment”. In the time since the Dodd-Frank Act was signed into law on July 21, 2010 and now, many financial institutions and other parties involved with debit card transactions have been busy studying the statute and developing scenarios to understand what form the regulations might take and how their organization would respond. By all accounts, the Fed’s draft rules addressing interchange rates and issuers’ network participation are worse than anyone’s worst‑case scenario.
Based upon the draft rules, debit interchange revenue for regulated card issuers will decline by 73%, from an average of $0.44 per transaction today to, at most, $0.12 per transaction, as of July 21, 2011. Furthermore, the proposed rates do not distinguish between signature debit and PIN debit, meaning that the revenue differential between these two forms of debit use is likely to decline or disappear. For the banking industry, almost $12 BN of non-interest revenue will vanish from the system.
Today, issuers generate an average of $87 of revenue per active consumer debit card per year; from July onwards, for banks with at least $10 BN in assets, this figure will drop to $24 per year (equating to $13 per card, across all debit cards).
The median variable cost for an issuer to perform a signature debit transaction is $0.175, based on a narrow definition of “allowable costs”. The result is clear: with the new rates set only in reference to a limited subset of all debit card costs, and only based upon variable costs at that, the economics of operating a debit card program will become significantly unprofitable.
The question of issuer participation in debit card networks remains unresolved. The Fed is considering one of two potential rules:
On December 16, 2010, the Federal Reserve released its proposed rules to regulate the US debit card market, as required by the “Durbin Amendment”. In the time since the Dodd-Frank Act was signed into law on July 21, 2010 and now, many financial institutions and other parties involved with debit card transactions have been busy studying the statute and developing scenarios to understand what form the regulations might take and how their organization would respond. By all accounts, the Fed’s draft rules addressing interchange rates and issuers’ network participation are worse than anyone’s worst‑case scenario.
Based upon the draft rules, debit interchange revenue for regulated card issuers will decline by 73%, from an average of $0.44 per transaction today to, at most, $0.12 per transaction, as of July 21, 2011. Furthermore, the proposed rates do not distinguish between signature debit and PIN debit, meaning that the revenue differential between these two forms of debit use is likely to decline or disappear. For the banking industry, almost $12 BN of non-interest revenue will vanish from the system.
Today, issuers generate an average of $87 of revenue per active consumer debit card per year; from July onwards, for banks with at least $10 BN in assets, this figure will drop to $24 per year (equating to $13 per card, across all debit cards).
The median variable cost for an issuer to perform a signature debit transaction is $0.175, based on a narrow definition of “allowable costs”. The result is clear: with the new rates set only in reference to a limited subset of all debit card costs, and only based upon variable costs at that, the economics of operating a debit card program will become significantly unprofitable.
The question of issuer participation in debit card networks remains unresolved. The Fed is considering one of two potential rules:
- All debit cards must participate in at least two unaffiliated debit card networks. In all likelihood, this will mean one network for signature debit and a different unaffiliated network for PIN debit.
- All debit cards must be in at least two different networks for each authentication method (i.e., two networks for signature debit, and two networks for PIN debit).
Regardless of which network rule is adopted, there will be significant operational upheaval and customer disruption for many issuers. This rule applies to all financial institutions, whereas the Fed’s regulation of interchange revenue applies only to issuers with at least $10 BN in assets.
In short, the proposed Regulation II, as required by the Durbin Amendment, will have a material impact upon all retail banks.
We summarize in this paper key aspects of the Durbin Amendment and the draft rules recently released by the Federal Reserve (the final rules are scheduled to be announced on April 21, 2011). We also provide some perspectives on what banks ought to do now.
In sum, we believe that all retail banks need to pursue multiple concurrent strategies to prepare their business for these upcoming changes to the debit card market. These strategies include: (a) restructuring the core debit card business, (b) re-pricing and repositioning the underlying DDA and associated payments businesses, and (c) responding to the request for comment on the Fed's draft rules.
AuthorTony Hayes, Partner in the North America Retail and Business Banking Practice
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